High profits mask banks' fears

The big high street banks are facing an uncomfortable annual results reporting season, starting with Lloyds on Friday. Despite making good profits the banks fear the advent of a Labour government and the continued absence of any real signs of underlying growth. Bad debts may be plummeting as the economy grows strongly, but threats by the Labour Party, coupled with flat loan growth, are leaving the stock market wary of the sector.

Yesterday Lloyds Bank saw its shares fall 4p to 546p, while TSB, which reported lacklustre figures three weeks ago, shed 5p to 247p.

The big four, Lloyds, Barclays, NatWest and Midland, should report 1994 profits of nearly £5bn after bad-debt provisions, compared with £3.5bn last time. This is the biggest recovery in profits since the Government imposed a windfall tax on the clearing banks in the early 1980s.

The dramatic leap is due overwhelmingly to falling provisions against bad debts rather than to growth in the banks' main business - lending. Loan growth remains flat as businesses and individuals remain wary of debt.

Falling provisions against sour loans also served to flatter profits in last year's reporting season, and analysts reckon the industry is approaching the bottom of the provisioning cycle. There are even signs that corporate lending is about to pick up, and with it the propensity of banks to incur bad debts.

Analysts are worried that intense competition has driven down lending margins to painfully low levels.

There are also widespread fears in the City that the banks will use big profits to go and buy other businesses, for the growth they cannot achieve in their own business. The City would not be thrilled by a rash of bids with banks offering to pay two to three times net assets for target companies.

There is certainly plenty of cash coming down the line. According to NatWest Markets, next year the four big banks will report profits after provisions of over £6.1bn, as bad debts fall even further to £1.45bn.

A static loan market means that bank results will depend very much on cost control. This factor was highlighted last week when NatWest warned its staff that it was starting a pay freeze - a path that Lloyds embarked on last year. Staff cuts and branch closures will remain a badge of management's devotion to shareholder value.

Further fuelling stock market concerns about the clearing banks is Labour's highly publicised criticisms of rising profits. The banks have been able to refute most of the attacks concerning rising charges during the recession, but bashing the banks remains politically popular.

One big drag on profits over 1994 has been the collapse in dealing profits. The collapse of the bond markets last spring and the ensuing weakness of equity markets has hit the banks' treasury operations as well as their investment banking divisions.

This will be less of a problem for Lloyds, which under chief executive Brian Pitman has withdrawn from non-retail activities and bid for Cheltenham & Gloucester Building Society, with the prospect of a relatively cheap retail customer base.

By contrast Barclays and NatWest have invested heavily in their investment banking sides, BZW and NatWest Markets respectively. Both banks have decided to follow their traditional corporate customers on the path away from lending and into the capital markets.

Goldman Sachs, one of the more bearish houses on banks, expects Barclays' pre-tax profits to almost triple, from £664m to £1,985m - a spectacular rise due mainly to bad-debt provisions falling from £1,869m to £600m.

Pre-tax profits at NatWest should rise from just under £1bn to just over £1.5bn, with bad-debt provisions down from £1,262m to £670m. Lloyds should enjoy almosty exactly the same profits growth, from £1bn to £1.5bn, but starting with far lower bad debt provisions of just £500m last time