Banks set to report good news on bad debt

When Northern Rock kicks off the reporting season for UK banks on Wednesday, it is expected to signal good news: that the explosion in consumer bad debts is finally peaking.

Analysts estimate that bad debt charges for UK retail banks will be broadly flat at about £2.8bn in the first half - the same as for the first half of 2006 - as consumers continue to struggle to repay credit cards and loans.

But the banks face a new threat: spiralling numbers of customers reclaiming past "unfair" overdraft charges.

According to an estimate this week from Credit Suisse analysts, banks have paid out £200m in the first half of 2007. One bank described the estimate as "conservative".

Customers have claimed that unauthorised overdraft charges - as much as £25-£38 per incident - were "unfair".

The claims started to flood in last year after consumer groups including Which? and websites such as Moneysavingexpert.com told people how to reclaim charges. The Office of Fair Trading is investigating overcharging, helping fuel claims.

This year some big lenders have had 500 claims a day, although volumes are thought to have dropped.

HBOS, HSBC, Lloyds TSB, Barclays and Royal Bank of Scotland are expected to be the worst hit.

Moneysavingexpert.com estimates that 4m forms to reclaim charges have been downloaded from its website.

Thousands of legal claims against overdraft charges are placing a growing strain on the court system. Many banks are paying outwithout fighting claims. The bank results are important because it is the first time the sector has had to quantify how much the claims are costing them.

Jonathan Pierce, banks analyst at Credit Suisse, expected the impact of claims to be about 1 per cent of group profits. He doubted that every bank would disclose the numbers.

The claims are likely to offset improvements coming through from corrective action by UK banks to rein back unsecured lending, which has helped stem the tide of bad debts.

Since 2005 banks have become stringent on new lending and made it far tougher for consumers to take out unsecured loans and credit cards. Rejection rates at Barclaycard are about 60 per cent. Lloyds and other banks are advancing unsecured loans only to existing customers.

This action is starting to translate into lower arrears. It takes 18 months to two years for a loan or credit card to go sour.

Banks have also started to become more proactive about dealing with customers who get in financial difficulty. Now they put them on Debt Management Plans, where all debts are repaid over a longer period, instead of letting them become insolvent and take out individual voluntary arrangements.

Banks have become concerned about IVAs - a less onerous form of bankruptcy for the consumer in which lenders write off part of the debt. There were 44,000 IVAs in 2006 compared with 5,000 in 2002 with debt management companies springing up to offer them.

Banks dislike the arrangements because they have to "forgive" up to 75 per cent of the amount owed. Bank creditors must agree each IVA by a 75 per cent majority but in recent months banks have taken a tougher stance and encouraged customers to go on Debt Management Plans instead.

"We are getting a lot better at that," said a senior executive at one of the UK's biggest banks. "Banks get out of practice when consumer debts are low."

Antony Broadbent, analyst at Bernstein, said: "We think bad debts are peaking and things certainly look better. The banks tightened credit criteria two or three years ago, which is feeding into better levels of arrears. Also unemployment has been falling and consumers can more easily repay debt."

Credit Suisse expects total group bad debts will rise at Barclays to £1.139bn in the first half of 2007.

Lloyds can expect a modest rise of £28m from the first half of 2006 to £828m, and RBS from £887m to £952m. At some banks there may be a modest fall. Total bad debts at HBOS are expected to fall from £864m to £832m.

The problems have not yet spilled over into mortgage lending. Arrears and repossessions are extremely low.

But mortgage repayments for up to 1m homeowners could jump by almost a third in the next 12 monthsas fixed-rate deals takenout in 2005 shift to higher rates.