This report does not constitute a rating action.
U.K. banks' results were strong for full-year 2023, though the second half marked a slow down as interest rates reached a cyclical peak. Even though deposit migration was a universal experience for the sector, its impact was uneven, with some rated banks seeing faster margin compression than others. A rapid tightening of margins through the second half of the year came alongside benign asset quality, with nonperforming loans rising only gently from the floor, and disciplined cost control, even in the face of steep inflation. This combination was a boon to 2023 earnings.
Some of the supportive dynamics in 2023 look set to cool through 2024, however. S&P Global Ratings nonetheless anticipates another solid year for the U.K. banking sector, with good earnings, meaningful capital distribution, and controlled balance-sheet expansion leaving capital, funding, and liquidity metrics comfortably within target ranges.
Here, we outline our main takeaways from published financial reports for full-year 2023. Rated banks reporting their full year 2023 results in the past two weeks include Barclays PLC (BBB+/Stable/A-2), HSBC Holdings PLC (A-/Stable/A-2), Lloyds Banking Group PLC (BBB+/Stable/A-2), NatWest Group PLC (BBB+/Stable/A-2), Santander UK Group Holdings PLC (BBB/Stable/A-2), and Standard Chartered PLC (BBB+/Stable/A-2).
1. Last year's earnings were robust across the board. Deposit-heavy U.K. banks reported strong earnings, supported by international monetary policy tightening in the second half of 2022 and the first half of 2023. This revenue tailwind subsided through late 2023, as rates reached their cyclical peak and depositors continued to switch their funds to higher-paying products. Even so, disciplined cost control and extremely benign asset quality saw banks report returns that comfortably exceeded pre-pandemic levels (see chart 1).
Chart 1
2. Deposit movements and a competitive mortgage market compressed net interest margins in the second half of 2023. Margins climbed through the first half of the year, but balance sheets were slow to reprice after central bank rate hikes, with deposit interest rates rising only gradually. This trend halted abruptly in the second half of 2023, as deposit migration took off. Bank of England data shows that, through June to December, more than £30 billion of retail deposits flowed out of retail current and instant-access accounts, swelling term deposit balances in the process (see chart 2). This rapid shift in the deposit mix was accompanied by a rise in deposit betas (the percentage of changes in market rates that banks choose to pass on to their customers). Consequently, net interest margins contracted sharply in the third quarter but less so in the fourth quarter (see chart 3).
Chart 2
Chart 3
Mortgage loan margins have narrowed steadily over the past 18 months. By our estimates, average completion margins on five-year, fixed-rate mortgages with a loan to value of 75% were about 20 basis points (bps) lower in 2023 than in 2022, and about 70 bps below the peak in 2020. This indicates intense competition, spurred by sluggish mortgage completion volumes and lower-margin refinancing of a sizeable portion of loans (see chart 4). The rolling average margin on five-year mortgage loan books has tightened significantly by our estimates, sitting at 120 bps as of Jan. 31, 2024, after a high of 140 bps in August 2020. This situation represented a major drag on banks' net interest margins in 2023.
Chart 4
3. Varying deposit mixes and strategies mean the margin decline was not homogeneous. Not all banks saw the same extent of margin compression. We believe some U.K. banks, like NatWest, were more proactive in repricing deposits through the first half of 2023, launching competitive products in anticipation of product switching. To this end, term deposits form a significant part of the funding mix of a bank like NatWest, versus a smaller share at peer banks, including HSBC UK and Barclays UK.
For example, about 10% of Barclays UK's deposit base consisted of time deposits, versus 16% for NatWest. This weighting contributed to the relatively different changes in the net interest margin reported by different banks. However, not all banks calculate this margin in the same way, so it is difficult to make a direct comparison. Furthermore, when we widen our study to include group-level disclosures, we see that all banks saw a migration of non-interest-bearing accounts in 2023 to interest-bearing account types (see chart 5). It is largely this foundational shift that explains the decline in margins across U.K. banks.
Chart 5
4. Asset quality was surprisingly resilient in 2023. Banks' average stage 3, or credit impaired, loans made up 1.9% of total systemwide loans at year-end 2023. This figure was about 20 bps lower than the pandemic high of about 2.1% in 2020 and slightly up from 2022 (see charts 6 and 7). At the same time, provision coverage has risen, with average stage 2 coverage ratios at 3.2% for our sample, up modestly year on year. Stage 3 coverage also rose to 32.3% from 31.8%, another modest increase. Given that 11% of U.K. banks' loan books were in stages 2 and 3 at year-end 2023, but the slight rise in overall coverage was a driver of full-year 2023 impairments.
Chart 6
Chart 7
A steady flow of mortgages was refinanced through late 2022 and in 2023, with trade association UK Finance estimating that about 1.4 million fixed-rate residential mortgage loans were reset in 2023. Of these, loans refinanced from a rate below 2.5% made up about half of the average completions for the banking system. Nonetheless, the growth of nonperforming loans was well contained (see chart 7 above), and we note that reported arrears remained subdued in late 2023. This is despite the payment shock experienced by more than 2 million U.K. retail mortgage holders in the past 18 months (see chart 8).
Chart 8
Even though nonperforming loans are still limited, U.K. banks are wary of the subdued domestic macroeconomic environment. Mindful of the potential downside from economic stagflation, banks' use of post model adjustments persisted through 2023, bolstering their provisions by about £1.6 billion (see chart 9). These adjustments focus on U.K. mortgage and commercial exposures, which have performed robustly through a period of economic weakness, but where banks believe IFRS-9 models do not adequately reflect the related potential negative credit impacts and lingering effects of the steep rise in the cost of living.
Chart 9
5. Well-disciplined cost control was essential to U.K. banks' earnings. For much of the banking sector, earnings contained a relatively limited number of extraordinary items, with a drop in restructuring expenses and extraordinary one-off charges for most issuers. That said, the sector's largest players--Barclays and HSBC--reported extraordinary items in the fourth quarter. Previous cost-savings programs ultimately enabled banks to push back hard against service and wage inflation in 2023, and cost to income was solid across much of the sector (see chart 10). Ring-fenced banks are often the most cost-effective members of their groups, with a cost-to-income ratio that is, on average, 4 percentage points lower than the broader group.
Chart 10
On balance, we see that Barclays lags the other U.K. banks in terms of operating efficiency. This is partly due to Barclays' business mix, which has a large proportion of more-expensive investment banking and markets divisions. But its U.K. operations also runs with higher costs than peers'. To this end, Barclays' strategy update for 2026 targets £2 billion of efficiencies and a cost-to-income ratio in the mid- to high-50% range (see "Barclays Eyes Higher Returns in Its U.K. Heartland," published Feb. 21, 2024, on RatingsDirect).
6. The FCA's motor finance review is looming. Some of the U.K.'s major banks play an important role in the country's motor finance market. As of year-end 2023, 2.5% of Santander UK's gross loans comprised motor financing and, for Lloyds, the figure was 3.4%. Barclays has a smaller presence in the market. Not only was its motor finance book much smaller than 2.5% of its gross lending book on Dec. 31, 2023, but it also exited this market in 2019 after years of minor market shares.
In any case, motor finance providers are fundamentally exposed to the FCA's (Financial Conduct Authority's) investigation into the vehicle finance industry, which centers on complaints relating to discretionary motor finance loan commissions that were banned in 2021. To date, the outcome of such investigations has been mixed. Some complaints were upheld by the Financial Ombudsman Service, while others were rejected in the county court system. This uneven experience creates uncertainty about the ultimate impact of the FCA's investigations.
Lloyds, for example, set aside £450 million of provisions in the fourth quarter of 2023 to capture estimated administrative costs associated with the FCA review and an initial estimate of customer remediation costs. The exact split was not disclosed. The FCA is still conducting its investigations and hasn't yet decided whether there was misconduct. If the FCA finds that there was misconduct, the redress cost will depend significantly on factors such as the "acceptable" commission rate or whether payouts are deemed to be proactive by the regulator. To this end, estimates like Lloyds' are a starting point in a long-running process.
The FCA's review is slated to end in September 2024. Until then, the impending outcome will occupy prominent car finance providers for the first nine months of this year and could give rise to material, but in our view affordable, provisioning needs.
What 2024 might bring
The six major U.K. banks that have published reports for the 12 months to Dec. 31, 2023, have distributed or announced £29 billion of dividends and share buybacks this year on the back of elevated earnings. With rate cuts in the offing, banks' guidance (from Barclays, HSBC, Lloyds, and NatWest) suggests overall lower but still robust performance in 2024, with the return on total equity averaging 13%.
Assuming an accumulation of risk-weighted assets following regulatory shifts and idiosyncratic growth, this looks set to leave U.K. banks comfortably within their target capital ranges by the end of this year. At the same time, S&P Global Ratings expects banks' funding and liquidity metrics to remain as solid as in 2023 as key supports, such as their large deposit bases, change over time ("As Their Funding Evolves, U.K. Banks Have Flexibility," published Sept. 14, 2023).
| U.K. banks' capital positions for fiscal year 2023 | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Barclays | HSBC | Lloyds | NatWest | Santander U.K. | Standard Chartered | |||||||||
| CET1 ratio (%) | 13.8 | 14.8 | 13.7 | 13.4 | 15.2 | 14.1 | ||||||||
| CET1 ratio target (%) | 13.0-14.0 | 14.0-14.5 | 13.5 | 13.0-14.0 | N/A | 13.0-14.0 | ||||||||
| Announced and paid dividend | £1.25 billion | $12 billion | £1.65 billion | £1.5 billion | £1.5 billion | $728 million | ||||||||
| Announced and completed share buy backs | £1.75 billion | $7 billion | £2 billion | £2.1 billion | None | $2 billion | ||||||||
| N/A--Not applicable. CET1--Common equity tier 1. Source: S&P Global Ratings. | ||||||||||||||
Related Research
- Barclays Eyes Higher Returns in Its U.K. Heartland, Feb. 21, 2024
- U.K. Banks Credit Outlook 2024: Earnings Stay Solid As Margins Ease, Jan. 4, 2024
- Banking Industry Country Risk Assessment: United Kingdom, Nov. 28, 2023
- U.K. Economic Outlook 2024: More Stagflation Ahead, Nov. 27, 2023
- Bulletin: Autumn Statement 2023: Spending Budgetary Windfall On Tax Cuts Won't Help Rebuild The U.K.'s Diminished Fiscal Headroom, Nov. 23, 2023
- Bulletin: U.K. Bank Earnings Lose Their Fizz In The Third Quarter, Oct. 30, 2023
- United Kingdom 'AA/A-1+' Ratings Affirmed; Outlook Stable, Oct. 20, 2023
- Metro Bank's Rescue Deal Has No Direct Consequence For Rated U.K. Banks, Oct. 9, 2023
- As Their Funding Evolves, U.K. Banks Have Flexibility, Sept. 14, 2023
- U.K. Banks Enjoy Another Strong Half Year As Margins Peak, Aug. 24, 2023
- Latest BoE Stress Test Signals U.K. Banks' Resilience To A Severe Downturn, July 12, 2023
- Comparative Statistics: U.K. Banks Compete Strongly As Rates Climb, June 16, 2023
- U.K. Bank Credit Losses Will Rise Modestly To £5.2 Billion In 2023 As Marginal Borrowers Feel The Strain, April 26, 2023
| Primary Credit Analyst: | William Edwards, London + 44 20 7176 3359; william.edwards@spglobal.com |
| Secondary Contacts: | Richard Barnes, London + 44 20 7176 7227; richard.barnes@spglobal.com |
| Rohan Gupta, London +44 2071766752; rohan.gupta3@spglobal.com | |
| Emelyne Uchiyama, London + 44 20 7176 8414; emelyne.uchiyama@spglobal.com | |
| Research Contributor: | Ankit Jalan, CRISIL Global Analytical Center, an S&P affiliate, Mumbai |
| Additional Contact: | Financial Institutions EMEA; Financial_Institutions_EMEA_Mailbox@spglobal.com |
No content (including ratings, credit-related analyses and data, valuations, model, software, or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced, or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees, or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness, or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment, and experience of the user, its management, employees, advisors, and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.spglobal.com/ratings (free of charge), and www.ratingsdirect.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.spglobal.com/usratingsfees.