The profitability of the domestically focused banks has come under increased scrutiny after the Brexit vote, with yields at fresh lows and predictions that the housing market could falter next year.
Shares in Lloyds (LLOY) and Royal Bank of Scotland (RBS) lost 41 per cent and 30 per cent, respectively, in the days following the announcement of the result, while challenger banks such as Shawbrook (SHAW) and Aldermore (ALD) also suffered huge share price losses. These banks have the largest retail operations and exposure to the UK housing market.
Expectations that the Bank of England would keep interest rates lower for longer sent 10-year gilt yields down to a record 0.93 per cent low at the start of the week. The knock-on effect for UK banks such as Lloyds, Barclays (BARC) and RBS, is that low rates could squeeze net interest margins even further. This is because the spread between the rate at which they can charge interest on long-term loans would come down, in comparison to the interest they pay out on customer deposits. These margins had already been squeezed by increased competition in the residential mortgage market.
Lloyds has a larger back book of high-interest-charging loans, which are maturing, but its strong market share allows it to write new business at higher rates than competitors. "The gap between a lot of its back book and front book is not nearly as wide as its peers'," says Investec analyst Ian Gordon. It also has a lower proportion of non-interest-rate-paying current accounts, compared with competitors such as RBS. As these are backed by swaps, the low-rate environment is expected to squeeze margins here also.
Challenger banks such as OneSavings Bank (OSB), Aldermore and Shawbrook are arguably more cyclical in their concentration on lending to UK SMEs and the buy-to-let market. Any fall back in the property market or decline in appetite for credit would hit these lenders hard.
