U.K. banks' 2023 net interest margin expectations are too conservative as they assume stronger headwinds from rate hikes while minimizing positive factors, analysts said.

Several of the country's largest lenders, including Lloyds Banking Group PLC, NatWest Group PLC and Barclays PLC, disappointed the market with more-cautious-than-expected 2023 NIM outlooks when they released their 2022 earnings reports in late February.

Analysts attributed the gap between their estimates and the banks' own guidance to two main factors: lenders' assumption that the Bank of England will not increase interest rates further in 2023, and their prediction of a much faster pace of passing rate hikes on to depositors, the so-called deposit beta.

There are risks of deposit betas "rising materially," especially amid recent political pressure on banks for a faster transfer of higher rates to savers, analysts at stockbroker Goodbody said in a March 1 research note. Yet the industry's assumptions of deposit betas reaching around 50% in 2023 are still "too conservative" given the prospect of more BoE hikes and tailwinds from banks' structural hedges against higher rates, they said.

Great expectations

Current consensus estimates forecast continued NIM growth in 2023 at the five largest U.K. banks by assets: Barclays, HSBC Holdings PLC, Lloyds, NatWest and Standard Chartered PLC. All except HSBC are also expected to book higher NIMs for 2024, which shows the market still sees more rate-related benefits than pitfalls for the industry.

Big U.K. banks have based their 2023 NIM guidance on assumptions of "much higher deposit betas than [we think] will play out in reality," Citi analyst Andrew Coombs said in a Feb. 22 note on Lloyds' results.

Some banks' expectations for BoE rate levels in 2023 are also misaligned with those of the market, resulting in a more cautious NIM outlook, analysts at Berenberg said in February notes on U.K. banks' earnings. Both Lloyds and NatWest assume the BoE base rate has already peaked at 4%, while the market considers further BoE rate hikes of up to 4.5% possible, the analysts said.

The BoE's monetary policy committee raised the base rate by 50 basis points to 4% on Feb. 2 and is due to meet again March 23. Another 25-basis-point rate hike in March is likely amid ongoing concerns about persisting U.K. inflation, economists at ING and UBS have projected.

Some corrections to NIM consensus estimates, aligning market expectations to the banks' 2023 guidance, were visible after the February earnings reports, with notable downgrades for Barclays and Lloyds, S&P Global Market Intelligence data shows.

Banks' management teams have anchored the 2023 NIM guidance "more conservatively and closer to what an appropriate number would be for 2025, assuming a BoE rate of 3%," Credit Suisse analyst Omar Keenan wrote in a Feb. 20 note.

While Credit Suisse still expects 2023 NIMs to be above the banks' guidance, the industry's more cautious approach "broadly makes sense," especially if consensus estimates are "not factoring the proper shape of likely NIM progression" over the 2023-2025 period, Keenan wrote.

Fine margins

All the major U.K. banks, apart from Barclays, beat 2022 NIM consensus estimates, Market Intelligence data shows.

At 3.1%, fourth-quarter 2022 NIM at Barclays' U.K. arm was also below consensus, mainly due to rate headwinds on treasury assets, Berenberg analysts said in a Feb. 16 note. The bank did not provide NIM consensus estimates in its pre-earnings consensus report.

Among the peer group, HSBC, Lloyds and Standard Chartered beat market expectations for fourth-quarter 2022 NIM.

In addition to mortgage margin pressure, Barclays U.K.'s fourth-quarter NIM was affected by an "extremely sharp" rise in interest rates on fixed rate bonds, a negative effect that is expected to "dissipate over time," Barclays Group Finance Director Anna Cross said on the bank's 2022 earnings call Feb. 15.

The bank expects further gains from the structural hedge it set up to mitigate the impact of higher rates and guides for 2023 NIM of greater than 3.2%, which is above the fourth-quarter 2022 result, Cross said.

Yet, the 2023 NIM guidance was well below market expectations, which led to an 8% drop in Barclays' share price on its earnings release date and is likely to trigger cuts in consensus forecasts for the bank's pretax earnings and revenues in 2023, Berenberg analysts said.

Lloyds also disappointed with its 2023 guidance as the market expected the bank to be able to maintain a NIM closer to the 3.22% booked in the fourth quarter of 2022. Lloyds cited deposit repricing and mortgage rate compression as key factors affecting NIM growth in 2023.

Analysts consider Lloyds' BoE rate assumptions as too conservative but also note that the group is more exposed to mortgage repricing headwinds than its peers. Lloyds is the U.K's. largest mortgage provider.

While NatWest's 2023 NIM guidance was in line with its 2022 fourth-quarter level of 3.2%, Berenberg analysts said the group's cautious assumptions mask some future rate-related benefits.

NatWest is likely to gain at least £200 million in additional revenue from further rate hikes in 2023, and another £200 million from reinvesting the deposit hedge at higher yields than the 3.3% the bank currently assumes, the analysts said.