The Best Of Times For British Banks

Strength in the economy and savvy management are adding up to fat profits

On Mar. 1, HSBC Holdings PLC delivered a stunner: the largest profit ever reported by a British bank. HSBC, the world's second-largest bank by market value, said net profit surged 41%, to an all-time high of $8.77 billion, on a 54% rise in revenue, to $41.1 billion. Most of the gains came from two acquisitions last year: Household Financial in the U.S. and Mexican bank Grupo Financiero Bital, now known as HSBC Mexico. That gave the London bank, which is strong in Asia and already earns a third of its profits from North America, millions more New World customers. "Our record results show the diversity of our business against a backdrop of improvement in most of the world's major economies," said HSBC Chairman Sir John Bond.

Those bullish numbers have kicked off what's expected to be another banner year for British banks. In recent weeks, along with HSBC, its rivals Barclays, Royal Bank of Scotland Group (RBS), and Halifax Bank of Scotland (HBOS) have all announced record profits. Like HSBC, RBS is taking advantage of its excellent cash position to make acquisitions overseas. Last year, Chief Executive Fred A. Goodwin carried out eight acquisitions around the globe, including credit-card issuers in Germany and the U.S. In the coming months, analysts expect Goodwin to do even more deals. With the exception of smaller players such as Abbey National, which has fallen on hard times fending off larger rivals in the insurance arena, British banks are the champions of Europe in terms of profits. "Things have never been so good for the British banks," says Alex Potter, a banking analyst at Lehman Brothers Inc. (LEH ).

The turbocharged earnings are a product of low interest rates, surging demand for mortgages, savvy expansion into foreign markets, and plenty of good old-fashioned ingenuity. What's more, the British banks have managed to steer clear of the bad loans and scandals that have bedeviled their peers on the Continent, in Japan, and in the U.S. Another reason the banks are so profitable is that the biggest ones have a home-field advantage. The top four British banks lord over 57% of their market, compared with 46% for the top four French banks and 19% for Germany's four biggest private banks. (Germany's regional state-owned banks provide heavy competition.) The dominance of the top British banks helps solidify their base, giving them a powerful springboard to launch into markets overseas. What's more, unlike much of the rest of the world, Britain didn't slip into recession in 2001. Instead, the economy has been chugging along, producing stronger-than-expected growth rates quarter after quarter. "The economy has been very kind [to the banks]," says Noel Reynolds, an analyst at Commerzbank Securities in London. That has helped boost demand for financial products. "Successful economies tend to breed successful banks," says HSBC's Bond.

Britain's own market is so promising that, unlike HSBC and RBS, which are concentrating their firepower overseas, banks such as HBOS -- which was formed by a 2001 merger between mortgage lender Halifax PLC and the Bank of Scotland -- are firmly fixed on expanding their business at home. HBOS CEO James R. Crosby's domestic strategy has worked like a charm: Last year, the profits at HBOS soared 29%, to $7 billion, on its strength in retail services, including a large network of automated teller machines and a white-hot mortgage businesses.

SWEET DREAMS? What might yet knock Britain's banks for a loop? Sharply higher interest rates. They would crimp highly leveraged spending, slow down the economy, and trigger a rash of loan defaults and bankruptcies. "A combination of a rapid rise in interest rates and a massive fall in housing prices would cause levels of bad debt to increase," which would be bad news for the banks, says Philip Middleton, head of retail banking at Ernst & Young in London.

But with few signs of inflation, analysts don't expect to see that nightmare scenario play out in the near future. That means the good times are likely to continue to roll for Britain's banks.

By Laura Cohn, with Kerry Capell, in London and with David Fairlamb in Frankfurt

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