Key takeaways
- Net interest margins look to have peaked for banks with a UK focus, as consumers move money out of current accounts in search of higher rates
- The consumer remains resilient, debt defaults are less than banks expected so far
- At current valuations, the yields on offer look attractive and are supported by strong capital levels
This article isn’t personal advice. If you’re not sure an investment is right for you, seek advice. Investments rise and fall in value, so you could get back less than you invest. Past performance isn’t a guide to the future. Yields are variable and not guaranteed.
Have benefits from higher rates peaked?
The slew of interest rate hikes seen over the past year, has come as a welcome relief for UK banks who’ve had to manage through an extended period of ultra-low rates.
One way banks make money is the difference between the rates they pay to depositors versus the rates they receive on the loans they give out. This is known as the net interest margin.
Higher base rates are a tailwind. But pressure to pass more on to savers means banks aren’t seeing as much of a benefit as they did earlier in the year. There’s also a much higher focus from consumers to make sure their cash is going further. We’re seeing shifts away from current accounts in search of better rates from savings products, which aren’t as profitable for the banks.
Retail current account balances year-on-year
Source: Second quarter financial statements - NatWest, Barclays & Lloyds.
The benefits from higher rates look like they might have peaked, at least for those with a focus on UK operations. Lloyds, NatWest and the UK arm of Barclays are all expecting net interest margins to drop from here on out.
The consumer remains resilient
One of the downsides to higher rates is that at some point, borrowers simply can’t stomach the interest costs on their loans. Banks are constantly trying to judge what portion of loans will end up in default, and they have to account for any changes in their income statement as either an impairment charge, when they expect more defaults, or vice-versa when things look better.
Half-year loan loss provision (impairment charge) vs expectations
Source: Refinitiv Eikon 07/08/23, negative values indicate a lower impairment charge than expected.
We were expecting charges to come. The key for us was how those compared to expectations. And in the main, things were better than feared. Broadly speaking, banks aren’t seeing any major uptick in default levels, for now.
Yields look attractive
At current valuations, the banking sector’s offering some compelling yields.
The combination of a healthier rate environment and strong capital levels at the major banks support being able to pay out more to shareholders – of course, there are no guarantees. Yields are not a reliable indicator of future income.
Forward dividend yield
Past performance isn’t a guide to the future. Source: Refinitiv Eikon, 07/08/23.
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Buybacks are complementary to the dividend yields, and when you put the two together we think there’s plenty to keep investors happy while conditions remain supportive. Of course, there’s never any guarantee when it comes to buybacks or dividends, and they can just as easily be taken away if conditions turn.
Dividends vs share buybacks – what investors need to know
Unless otherwise stated estimates are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.
This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.
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