Major U.K. banks posted another robust set of results in first-half 2024, with a muted decline in asset quality and resilient NIMs. The six major U.K. banks--Barclays, HSBC, Lloyds, NatWest, Santander U.K., and Standard Chartered--reported aggregate profits before tax of £31 billion, versus £34 billion in first-half 2023 (see chart 1). This represents a sector-wide weighted-average RoTE of 14.8%, versus 16.5% in first-half 2023.

S&P Global Ratings believes that the banks' results provide an outline for future earnings(see table 1). NIM compression appears to have halted in the second quarter of the year, with banks reaping the benefits of rising gross yields on structural hedges. This has counterbalanced the adverse impact of deposit migration and mortgage margin compression, and we see it as likely to drive net interest income (NII) upward for most rated banks in 2025 and 2026. On top of this, tempered impairment guidance and good cost control provide additional support to the major U.K. banks' earnings outlook.

In sum, we see that the U.K.'s major banks have significant leeway for earnings growth in the next 12-24 months. We anticipate that they will channel this capital generation into significant shareholder distributions and selective bolt-on mergers and acquisitions (M&A) of the kind we have already seen Barclays, Nationwide, and NatWest announce in the past six months.

Our outlooks on these six major bank ratings are stable. We expect the stable trends to continue over the next 12 months, with positive rating actions unlikely amid muted economic growth. The main threats to the ratings are economic tail risks that trigger a material deterioration of asset quality.

Table 1

Chart 1

NIMs Finally Reach An Inflection Point

Improving new lending margins, stabilizing deposit costs, and rising structural hedge benefits have allowed U.K. banks to maintain elevated NIMs in the first half of the year, adding buoyancy to the NII and earnings outlook for the rest of the year.

The average NIM fell by just 13 basis points (bps) from first-half 2023, although varying deposit mixes and the timing of structural hedge maturities meant that NIM movements varied between banks (see chart 2). However, not all banks calculate this margin in the same way, so it is difficult to make a direct comparison.

Chart 2

Driving this incremental turnaround in NIMs is the fact that the structural hedge income benefits associated with higher swap rates are now offsetting both competition in the mortgage market and higher deposit betas, even as hedged deposit balances have continued to taper. The hedge programs' higher gross yields have more than offset the effects of this tapering. For example, Barclays' average hedge yield increased to 1.9% in second-quarter 2024 from 1.5% in 2023.

We expect this trend to continue as deposit migration to higher-rate fixed term accounts slows, while lending margin compression continues to stabilize as many high-margin pandemic-era mortgages have already refinanced to current front-book rates. These factors should support NIMs in 2024 and 2025.

Asset Quality Remains Robust

The U.K.'s economic outlook improved and unemployment remained low in the first six months of 2024 (see "U.K. Economic Outlook Q3 2024: A Cooling Labor Market Paves The Way For Rate Cuts," published June 24, 2024). This has supported credit quality in banks' portfolios despite higher borrowing costs.

Resilient corporate and retail asset quality, coupled with releases of management adjustments to modelled provisions, kept impairment rates at an average of 17 bps for the major banks in the first half of the year, well below the long-term average of around 30 bps. To this end, banks' average stage 3 or credit-impaired loans sat at 2.03% of total systemwide loans at half-year 2024, 7 bps lower than the pandemic high of around 2.1% in 2020, and largely stable from year-end 2023 (see chart 3).

Chart 3

However, not all lending segments performed equally as well. While nonperforming assets remained largely stable on average, nonperformance across banks' retail and wholesale lending books increased slightly compared with end-2023 (see chart 4). The largest absolute rise in nonperformance in the half year was in retail mortgages, but the impact of this on impairment charges was modest. This was due to the low provisioning needs for most U.K. mortgages in stage 3, which is a product of their low loan-to-value ratios.

Arrears in residential mortgage books are gradually rising from pandemic-era lows but remain below historic averages. General early-warning credit-quality indicators--for example 90-day arrears and the proportion of credit card borrowers making the minimum monthly repayment--have not seen a meaningful deterioration. This stable new-to-arrears measure suggests that a small but persistent stream of loans will become nonperforming. We regard this as a normalization of the credit environment for U.K. banks.

Chart 4

Banks Are Releasing Legacy Management Provisions

Post-model adjustments (PMAs) have fallen year-on-year as banks release management provisions in light of stronger-than-expected underlying asset quality performance. PMAs, which capture hard-to-model credit risks in lending books, are used by banks to "top up" their provisions and were kept elevated in 2022 and 2023 due to uncertain economic conditions on the back of persistently high inflation and interest rate uncertainty.

Banks have begun to release some of these provisions in the first half of 2024 on the back of stabilizing cost-of-living pressures and improved economic assumptions, with a combined release of £570 million of management provisions, compared with half-year 2023 (see charts 5 and 6 ).

The remaining adjustments focus on U.K. mortgage and commercial exposures, where banks believe that the potential negative credit impact of lingering economic uncertainty is not reflected adequately in International Financial Reporting Standard 9 models, even though these exposures have performed robustly through a period of economic weakness.

Chart 5

Chart 6

That said, loan staging remains more cautious than before the pandemic and in first half of 2022. Conservative definitions of a Significant Increase in Credit Risk (SICR) and pressures in the commercial real estate market are pushing more performing balances into stage 2. Nonetheless, we expect asset quality to remain resilient, with a steady and manageable normalization over the next 12-24 months. A further period of benign asset quality could pave the way for further PMA releases late in 2024 or early in 2025.

Loan Growth Picked Up In The Second Quarter Of 2024

Gross new lending picked up in the second quarter as new business margins improved and consumer confidence recovered, driving application volumes higher in both retail and commercial loan books (see chart 7). That said, net lending volumes were still subdued, particularly in the mortgage market, where redemptions continue to offset new lending, and where rising new applications will only appear in second-half lending volumes as transactions complete.

We anticipate that lending growth will continue in the second half of the year as volumes pick up in both the mortgage and corporate sectors thanks to a more certain interest rate environment and less inflationary pressures.

Chart 7

Deposit Accumulation Is Strong Among Leading Banks

Large U.K. banks saw deposit migration from non-interest-bearing to interest-bearing and higher-rate term deposits slow in the first half of 2024, while the overall mix of deposits stabilized (see chart 8). That said, deposit mixes and strategies vary between banks.

For example, Santander UK saw £5.6 billion of customer deposit outflows in the first half of 2024 due to its conscious repricing actions to maintain margins. Lloyds and NatWest saw £3.3 billion and £6.1 billion increases in deposits, respectively, driven by growth in savings balances across all business segments.

U.K. banks' liquidity remains solid, with liquidity coverage ratios remaining elevated and well above both the requirements and internal targets. We expect this trend to continue in the second half of 2024, even as liquidity coverage ratios begin to fall from their highs as deposits normalize, lending picks back up, and banks repay borrowings from the Term Funding Scheme with additional incentives for small and midsize enterprises (TFSME).

Chart 8

Growing Business Confidence Could Unlock Further Loan Growth

Data gathered by the Office for National Statistics revealed that 72% of businesses are more confident now than at any time in the past two years that their companies' performance will stay the same, if not improve, in the next 12 months (see chart 9). Fears among the same group of respondents have receded so far in 2024, with only 8.5% anticipating weakening performance in the next 12 months.

While the newly elected Labour government continues to face a difficult fiscal outlook (see "The U.K.'s Constrained Fiscal Position Implies Difficult Policy Trade-Offs For The Labour Government," published July 8, 2024), the decisive Parliamentary majority it won at the general election could support business confidence by enabling the creation of a more stable policy environment.

We do not anticipate that this rising tide of confidence will have immediate effects on banks' balance sheets and earnings. However, it has the potential to support lending and transaction volumes in the next 12-24 months, bolstering banks' margin performance.

Chart 9

First-Half Results Point To The Road Ahead For Major U.K. Banks

Capital generation from earnings and muted risk-weighted asset growth have offset higher shareholder distributions over the past 12 months.

Overall, we see positive momentum for major U.K. banks' earnings heading into the second half of 2024 and 2025. This is thanks to benign asset quality, moderately increasing margins, modest growth in new lending, and good cost control, alongside continued investments in franchises and technology. We anticipate that these earnings trends will enable banks to maintain elevated capital distributions over the next 12 months, while allowing for further acquisitions and the maintenance of regulatory capital ratios comfortably within their target ranges (see table 2).

Transformative M&A is still on the table in the U.K. banking sector, for example, Nationwide Building Society's agreed acquisition of Virgin Money UK (see "Nationwide's Surprise Offer For Virgin Money Would Be A Transformational Acquisition If It Proceeds," March 7, 2024). However, we expect the bolt-on acquisitions announced in the first half of 2024 by Barclays (Tesco Bank) and NatWest (Sainsbury's Bank and Metro Bank's mortgage book) to be the more likely route for the U.K.'s industry leaders as they look to put their capital generation to work.

Table 2

Related Research

• Economic Outlook Q2 2024: The U.K. Is Slowly Turning A Corner, March 26, 2024
• Nationwide's Surprise Offer For Virgin Money Would Be A Transformational Acquisition If It Proceeds, March 7, 2024
• Six Takeaways From U.K. Banks' Full-Year 2023 Results, March 6, 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
• United Kingdom 'AA/A-1+' Ratings Affirmed; Outlook Stable, Oct. 20, 2023
• As Their Funding Evolves, U.K. Banks Have Flexibility, Sept. 14, 2023