British Banks' Profits Surprise

HSBC and Barclays' positive results are welcome, but there's a Catch-22: Loan defaults could still rise, yet recovery won't come without increased lending

By Kerry Capell

European banks are following their American counterparts in reporting better-than-expected earnings, as fees from investment banking and securities trading help offset retail banking losses. On Aug. 3 the two British-based banks that refused to accept government bailouts during the worst of the financial crisis, HSBC (HBC) and Barclays (BCS), reported strong profits, sparking hopes that an economic recovery might finally be under way. Both banks announced first-half pretax profits of $5 billion—an 8% rise for Barclays but a 57% decline for HSBC, Europe's largest bank—compared with a year earlier.

Considering that many analysts had expected HSBC to slip into the red, the results were a positive surprise. The two British lenders follow the likes of Goldman Sachs (GS), Credit Suisse (CS), JPMorgan Chase (JPM), and Deutsche Bank (DB) in posting higher earnings on the back of a strong performance by investment banking. At Barclays Capital, the group's investment arm, profits more than doubled, to $1.7 billion. And pretax profits at HSBC's global banking and markets business more than doubled, to $6.3 billion, on an increase in currency trading and underwriting bond sales.

The strong numbers renewed optimism that the worst of the downturn may be over. It's likely that "we have passed, or are about to pass" the bottom of the cycle in financial markets, HSBC Chairman Stephen Green said in a statement. Careful to temper his upbeat remarks, though, Green cautioned that "the timing, shape, and scale of any recovery in the wider economy remain highly uncertain."

That's because any true turnaround depends on reviving banks' ailing retail operations—and so far, that hasn't happened. "The foundation for recovery is there," says Ralph Silva, research director at financial consulting firm Tower Group (TWGP) in London. "But if retail banking does not recover, there will be no recovery."

more damage from bad mortgage loans

Both Barclays and HSBC have suffered from the souring of a sizable chunk of their retail loans. Barclays' writedowns soared by 86%, to $7.8 billion, while bad debt charges at HSBC rose 39%, to just under $14 billion. Many of HSBC's problems are due to the poor performance of loans made by Household International, the U.S. subprime lender it acquired in 2003. HSBC's U.S. business posted a $2.9 billion loss for the period, though the bank says bad debts are rising at a slower rate after efforts in previous years to cut down on higher-risk loans. HSBC is in the process of winding down its U.S. operations after deciding in March that Household will not issue new loans.

The bad news is that many in the industry still expect the number of defaults to rise. On July 31, Deutsche Bank CEO Josef Ackermann predicted that even banks that have so far avoided losses are not immune to rising delinquencies by both corporate and consumer borrowers. "Bad loans are the next wave" of the financial crisis, Ackermann said.

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