UK banks may avoid worst of household debt pain

LONDON (Reuters) - Action taken by UK banks to rein in personal lending after a spike in bad debts two years ago could help them avoid crippling losses on consumer business as the economy nears recession and pressures on households increase.

Still counting the mounting cost of the credit crunch, Britain's banks are now faced with a broader economic slowdown and most lenders had rising arrears in home loans and among corporate customers in the first half of 2008.

Thanks to tighter practices and lower consumer credit balances, no major bank in Europe's most indebted country reported serious warning signs in unsecured losses -- leaving more concern about the future for bad debts in mortgages than in household loans and credit cards.

"It is not as if it is not going to cause the banks any pain, but because ... they've been dealing with it for the past few years, it won't be as bad as it could have been," analyst Leigh Goodwin at Fox-Pitt, Kelton said.

"If the banks had been coming off very low levels (of impairments), and had not tightened their lending criteria and risk modelling -- as was the case going into previous recessions -- all hell could have broken loose."

In Britain, the only country in Europe to have more credit cards than people, bad debts hit a peak around 2006, on the back of simplified bankruptcy legislation combined with several years of aggressive lending from banks keen to grab a slice of the lucrative credit card and loan market.

After a year of sobering impairment charges -- particularly at large consumer loan providers like Barclays (BARC.L), Lloyds TSB (LLOY.L) and at growing players like HBOS HBOS.L -- banks tightened up their practices and lending criteria.

At HSBC (HSBA.L), for example, branch employees are no longer allowed to override a rejection from the bank's formal system of approving loans, and it grants personal loans only to customers with a current account, which allows it to check affordability.

Banks also sold off less healthy loan portfolios. Barclays sold the bulk of its subprime card unit Monument last year, while HSBC, one of Britain's big four card issuers, sold off its Marbles and Beneficial-branded cards.

"The fact that we had a bit of a problem with unsecured (lending) has benefited the banks, because they cut back, recognized problems with the 2004 and 2005 vintages and changed criteria, toughened recoveries," Gordon Scott, managing director at Fitch Ratings, said.

"That may have been slightly painful at the time, but you didn't really notice it, because everything else was so good."

The jump in impairments and subsequent blow to interest income and fees as banks pulled back did dent profits. That was offset by growth elsewhere, including in wholesale divisions. Barclaycard alone had a 36 percent rise in bad debts at the peak in 2006 to 1.5 billion pounds, but still posted a 35 percent jump in profits.

DEBT BURDEN

With Britain's economy deteriorating and consumers finding themselves squeezed by mortgage costs, rising inflation and unemployment, few bet the country's banks will be able to avoid credit card and loan pain entirely.

Losses should be contained, however, thanks to the tightening and analysts say bad debts are unlikely to rise far beyond levels seen at the peak of the previous crisis in 2006.

They also say the situation is also unprecedented. The inflationary environment is very different from two decades ago, but consumers are heading into what could be the first recession since the 1990s with unparalleled levels of card and loan debt.

"Banks have been quite risk averse. They have taken the foot off the gas in terms of loan growth. They have taken provisions," analyst Mike Trippitt at Oriel Securities said.

"But there isn't much in the way of precedent. The early 90s was different in terms of unsecured lending. It will depend on the direction of interest rates, on unemployment rates."

According to official data, Britons owed 231 trillion pounds in card and loan debt at the end of June -- roughly 3,800 pounds per person. That compares to around 2,240 pounds in June 2001.

For the moment, concerns are elsewhere.

Mortgage arrears have already dented profits at some lenders in the first half of the year and most warned of a growing number of defaults among small and medium-sized firms.

"The corporate side is where we have to keep an eye on now. If we look across the first half of this year, although we have seen an increase in mortgage arrears and impairments, and this will continue for sure, it is the corporate bad debts that have moved the most," Fox-Pitt, Kelton's Goodwin said.

"This is the area that could apply the most unexpected pain in the second half and in 2009 if the broader economy stalls."

(Editing by Paul Bolding)