Britain's banks bounce back

High-street giants are back in profit and over the worst, but can they lend enough to drive the UK out of recession? Deirdre Hipwell reports

Britain's five biggest banks are forecast to report bumper half-year profits totalling more than £12bn this week, just a year after the sector was reeling from multi-billion-pound losses.

Lloyds Banking Group, Royal Bank of Scotland, HSBC, Barclays and Standard Chartered are expected to unveil healthy first-half pre-tax profits, largely driven by the easing of impairment charges, the cost to the bank of its bad loans.

However, the performance of the banks' different operating divisions will be mixed with trading revenues which in investment banking likely to disappoint the market, and raise concerns about the sector's underlying growth prospects.

A sharp eye will also be cast over new gross lending figures in the wake of Bank of England governor Mervyn King's stated "heartbreak" at how small UK businesses are being pushed to the wall by banks' tough terms, or their refusal to lend. The banks are likely to defend themselves against criticism with claims that they are preserving capital and setting aside funds to cover potential future losses rather than lending on uncommercial terms.

Gary Jenkins, banking analyst at Evolution Securities, said: "Some of the trading business line volumes will be down but it is more than offset by the reduction in bad debts. Banks are much of a muchness and if it is good for one it is good for all. It just shows how quickly things can turn around in the market. It is nothing like as bad as we had feared this time a year ago. The big question going forward is, in a year's time, will this bad debt provision remain on a downward trend? You hope volumes will pick up because, if not, the market has a problem."

Of the two banks – RBS and Lloyds – which have biggest government ownership interests, Lloyds will be the best performer. It is expected to report a pre-tax profit of £800m, which stands in stark contrast to its £4bn pre-tax first-half loss in 2009. It also remains on track to meet its targeted full-year 2 per cent net interest margin – a measure which banks use to gauge profitability. And with the share price closing on Friday at 69.26p, the Government and the UK taxpayer, which hold a 41 per cent stake, are sitting on a paper profit of around £1.9bn.

After a first-quarter operating profit this year, some analysts are expecting RBS, where the taxpayer has an 83 per cent economic interest, to remain in the black. Morgan Stanley analysts forecast results improving to a £420m pre-tax profit off the back of lower impairment charges and lower credit market losses. RBS results are also likely to be boosted by the imminent conclusion of a £1.75bn sale of 318 of its branches to the Spanish Banco Santander. However, RBS chief executive Stephen Hester has already warned that he expects RBS to report a loss for the full year.

With some US investment banks reporting a drop in second-half profits the market will look first to the performance of Barclays investment arm BarCap when it reports its figures on Thursday. BarCap has already said it had experienced weaker trading conditions in May and June. Barclays Corporate – one of the three divisions of the group – is also expected to report higher impairments with provisions against falling Spanish property values.

Barclays is expected to disclose a pre-tax profit of about £3.5bn, beating its 2009 first-half £2.75bn profit before tax. However, the £3.5bn figure will be helped by a gain of between £350m and £924m on the bank's own credit which, if excluded, means the first-half pre-tax profit is nearer to the £2.97bn mark. Its core tier one capital level is not expected to have significantly changed from the 9.8 per cent recorded at 31 March 2010 while it expects overall impairment in 2010 to improve between 15 and 20 per cent on 2009.

HSBC, reporting tomorrow, is expecting to post another strong half-year performance with an estimated pre-tax profit of $8.6bn, which is well ahead of $5bn pre-tax profit during the same period in 2009. The focus is likely to be on the bank's continued strong performance in emerging markets across Asia and a continued rebalancing of its business in a way which tracks trade-flow growth.

Another Asian-focused bank, Standard Chartered, whose biggest part of its business is in that region, is likely to report a US$3.1bn pre-tax profit driven by the relative strength of its consumer and wholesale banking divisions.

The results show a remarkable turnaround for the UK banking sector, which has come perilously close to collapse, and which started this second quarter buffeted by serious concerns about eurozone sovereign debt.

But confidence remains fragile. While it was almost inevitable that loss impairments would drop after such a long period of massive losses, there are still looming refinancing risks ahead for the banks. The Bank of England has said UK banks must refinance short- term debt of between £750bn and £800bn by the end of 2012. Next year alone there is a £250bn refinancing hurdle to meet at the same time that the Government will be withdrawing its guarantees and liquidity support.

UK banks are also driven by the country's credit quality, and any further financial shock could set back any profitable gains made now. The EU-wide bank stress testing carried out two weeks ago, which the UK banks sailed through, has gone some way to restoring confidence, but, as one analyst said, "the banks are still seriously far from out of the woods".

Motivating drivers of the UK's economy – such as employment, retail sales and housing prices – need to remain robust for a continued recovery. The central bank reported last week that mortgage approvals fell in June and were below forecasts, which may indicate that the revival in the housing market is slowing.

Mr King also said last week that he was less than sanguine about the UK's recovery despite its recorded 1.1 per cent GDP growth in the second quarter, and that there was "still some considerable distance to travel".