A number of pressure points continue to build for major UK banks and 2008 performance is likely to be weaker, says Fitch Ratings in a special report.

The rating agency said that in 2008, earnings have been, and will be, negatively impacted by write-downs due to US subprime and related credit exposures and the slowdown in parts of the wholesale and investment banking markets. However, for most of the major UK banking groups, tighter conditions in wholesale funding markets are more likely to be a growth-constraining factor than a material drag on earnings, it noted. In fact, it suggested that the relatively greater business constraints faced by smaller UK banks mean the major UK banking groups are well placed to pick up market share and at better margins.

With the exception of the spike in unsecured retail lending credit losses two years ago, asset quality in the major UK banks’ mortgage, commercial and corporate loan portfolios has been very strong -unsustainably so – for several years, it said. As a result, Fitch sees asset quality pressures building in the UK banks’ retail and corporate loan portfolios.

It believes that associated rising credit costs will be more of a 2009 and 2010 story than one for 2008. Positive credit loss trends in retail unsecured portfolios are likely to reverse at some point in 2008 or 2009 and mortgage-related losses will also face upward pressure as arrears rise from historically low levels and due to falling house prices, it noted. Even then, low mortgage loan-to-value levels are likely to offer significant protection against the risk of substantial mortgage-related losses, Fitch said.

In the corporate space, areas of growing concern are property lending (especially development finance and house builders) and parts of the retail sector. In the longer term, leveraged finance exposures (both drawn and undrawn) could also become more problematic if re-financing options remain constricted, it cautioned.

Fitch said it believes the major UK banks can absorb a reasonable level of adjustments, through diversified revenues and/or capitalization, but further negative rating actions remain possible. Two of the five major banks have already raised capital, and of the three others, Fitch said it believes Barclays is likely to seek to strengthen its capital position in the near-term, possibly through issuing new equity. It considers Lloyds and HSBC as being unlikely to raise new equity at present.

“2008 will prove a challenging year for the major UK banks, given the weakened prospects for the wholesale and investment banking markets and the continuing volatility of the financial sector,” says Cynthia Chan, director in Fitch’s Financial Institutions Group. “In light of the weaker earnings prospects and a more difficult economic outlook for the UK, measures being taken to strengthen capital by some banks are viewed positively by Fitch.”