Yet markets are still sceptical about the outlook for the domestic lenders and braced for further turbulence. In fact, shares in some of the UK’s banks sank to all-time lows this week. Is now the time to pick up some bargains, or should investors take heed?
Lenders’ balance sheets are in a much stronger position after they spent the past decade shedding risk-weighted assets to boost regulatory capital ratios and taking the painful hit to profitability that resulted from a litany of misconduct and litigation charges. The concern now stems from fears of a worsening macroeconomic outlook and a disorderly Brexit, which raises the threat of rising credit impairments and would give greater encouragement for the Bank of England to cut the base rate.
A cut to UK interest rates at December’s monetary policy committee meeting is now perceived as more likely than not, based on futures and options pricing data compiled by Bloomberg. Fears that the UK may be headed for a recession were exacerbated by weaker-than-anticipated activity data from the services sector, which has defied a much deeper decline in manufacturing and construction output over the past 12 months. Last month IHS Markit’s services purchasing managers’ index dropped to a reading of 50.6 – its worst performance since 2008, although still indicating a modest expansion.
That comes at a time when competition within the mortgage market is intensifying, a pricing war that has been exacerbated by the introduction of requirements for lenders to ring-fence their retail operations from riskier lending this year. Preventing banks from using their retail deposits to fund their investment banking operations has prompted some banking groups to lend more to UK households.
For example, earlier this month HSBC (HSBA) – which has lagged UK-listed peers in terms of UK mortgage market share –launched a 1.59 per cent five-year mortgage as part of plans to increase lending within this part of the UK market. Meanwhile, last week Santander launched the lowest five-year fixed-rate remortgage deal on the market at an interest rate of 1.55 per cent.
While lenders can offset some of this pressure by repricing the rates paid on customer deposits, the general consensus among analysts is that there will be a further squeeze on net interest margins in 2020. Investec’s Ian Gordon contends that only part of the benefits of lower swap rates have been passed through to customers. “Banks are showing an element of discipline,” said Mr Gordon.
The question for investors is whether the sharp devaluation in UK banking shares has pushed them into bargain territory, or if their income prospects are genuinely under threat. There is an argument that, for the retail banks, unemployment levels and real wage inflation are the determinants of whether borrowers will be able to keep up their repayments or whether impairment levels will rise. On both those scores the outlook looks positive – employment rose to a record high during the three months to July, according to data from the Office for National Statistics, and average earnings saw their fastest rate of growth since 2008. For well-capitalised domestically-focused banks such as Lloyds and Barclays, that is enough for us to keep the faith that those solid dividend payments will be maintained.
