This week’s reshuffling of UK mortgage rates is placing additional strain on bank profit margin forecasts, intensifying the challenges faced by a sector struggling to meet shareholder expectations.
The prices of numerous home credit products have experienced a decline since July, driven by speculation that the Bank of England (BoE) might expedite a reduction in its base rate of 5.25% due to supportive economic indicators, including a slowdown in inflation.
The start of the new year witnessed significant drops in primary mortgage interest rates, leading some analysts to question whether banks can still align with net interest margin forecasts (NIM), a critical measure of their earnings from loans.
Bank of America analysts (BofA) recently revised their 2024 earnings projections for UK banks downward by 7-12%, citing markedly lower market interest rate expectations that will exert pressure on banks’ profit margins.
Simultaneously, heightened competition among banks for mortgage activities and deposits is casting a shadow over potential returns for bank shareholders, according to analysts.
Laurie Mayers, Associate Managing Director at Moody’s Investors Service, stated, “We have probably reached the peak of profitability for most UK banks in H1 2023,” indicating an anticipated increase in pressure on both mortgage and deposit margins.
Banks have already signaled a diminishing profit boost resulting from interest rate hikes initiated by the central bank in 2022. Despite this, lenders are striving to maintain market share, with many offering improved rates due to cheaper funding in the wholesale market.
Moneyfacts data reveals that current best buys are more affordable than a year ago, with five-year loans under 4%, compared to a top rate of 4.39% in early 2023.
In response to the competitive landscape, HSBC unveiled a five-year fixed mortgage deal at 3.94% and reduced its 10-year fixed mortgage rate to 3.99%. NatWest also announced tariff reductions on selected mortgage deals.
The intensifying competition has implications for bank stocks, with Virgin Money and Barclays facing increased challenges in the current environment, experiencing a 2% and 1.35% decline, respectively.
NatWest and Lloyds, deemed more resilient by BofA analysts, also faced declines of 0.5% and 1.3%, respectively.
The impending end of the pandemic Terming Scheme is expected to shift the focus to customer deposits as a critical means of financing, adding pressure to maintain or grow these deposit bases.
As interest rates decline, there is an anticipation of potential pressure on net interest margins (NIM), especially if banks pass on lower rates to mortgage customers without being able to reduce payouts to savers. The situation is complicated by the need for banks to repay over £180 billion to the BoE, distributed to support loans during the pandemic.
Analysts anticipate that as base rates decrease, some depositors may switch to rivals offering more attractive rates, putting further strain on banks’ NIM forecasts. In response to these dynamics, banks may be compelled to seek more expensive sources of funding, potentially impacting their overall profitability.
