Britain’s upstart lenders face Brexit shock in first downturn

Bloomberg

Investors contemplating how London could look outside the European Union have already identified some potential victims: fast-growing British lenders that might have to face their first economic downturn as public companies.
Billionaire Richard Branson’s Virgin Money Holdings UK Plc and small lenders like OneSavings Bank Plc have ridden the recovering economy of recent years to help them win market share from the nation’s entrenched players. With the U.K. Treasury and some analysts predicting that a British vote to leave the EU on June 23 could cause the worst drop in house prices since the financial crisis, the banks could see their progress reversed as they’re saddled with bad debts.
“I’m still hoping common sense will prevail and we’ll remain in the EU,” OneSavings Bank CEO Andy Golding said by telephone. “I’m not necessarily certain if anyone knows what the result will be of an exit. But I am pretty certain it creates a slowdown in economic growth and creates less demand for new property.” The J.C. Flowers & Co.-backed lender is financially secure enough to withstand a downturn, but would “not grow at the same rate,” Golding said. “If growth slows, we’ll find it harder to keep growing.”
Chancellor of the Exchequer George Osborne is warning a vote to leave the EU may cause a “DIY recession” with rising unemployment and an 18 percent drop in house values. Share prices of five of the so-called challenger banks have dropped an average of 11 percent in June, as polls showed increasing support for a Brexit.
Home prices have already fallen in central London, according to the Royal Institution for Chartered Surveyors. Even at bigger banks like Royal Bank of Scotland Group Plc, chairman Howard Davies has noted a slowdown in loan demand he attributed to the referendum.
To be sure, pro-Brexit campaigners say EU rules are stifling the British economy and that local companies will fare better if they’re severed from the continent’s requirements. And not every challenger is certain that they’ll be hurt by a vote to leave.
“I don’t think this Brexit is going to have an impact on us,” Metro Bank Chairman Vernon Hill said. “There’s such gigantic market share to take, I don’t think we’re going to be affected by any macro event like that.”
Started in the ashes of the financial crisis, some of Britain’s challenger banks are built on the remnants of lenders that failed, while others were created from scratch. Their executives are typically former senior bankers with experience at firms such as RBS and Barclays Plc.

Profitability Threat
Until now, the challengers have enjoyed a robust housing market with Bank of England’s key interest rate at a record low. Lending increased by 32 percent last year for a group of the smaller banks studied by KPMG LLP in a report last month, compared with 4.9 percent fall for the country’s five-largest banks.
That has led to higher profitability, with an average return-on-equity of 19 percent for the five smaller firms that traded publicly last year, which could be derailed by an economic downturn.
The challengers have “neither gone through a full credit cycle nor had their books fully seasoned,” analysts at Citigroup Inc. led by Ian Sealey and Andrew Coombs wrote in a note to clients last month. “This is likely to put upward pressure on loan losses.” While Britain’s largest lenders and global investment banks in the country have said they may relocate staff elsewhere in Europe in the event of a Brexit, the challengers, typically focused on the U.K., lack such diversification. None have more than £40 billion ($58 billion) in total assets, a fraction of Lloyds Banking Group Plc’s £807 billion.

‘More Mature’
“Big banks are more able to withstand volatility compared to the challenger banks, especially those who do not have diverse products and more mature, substantial balance sheets,” said Richard Iferenta, a partner at KPMG LLP.
Brexit may lead to higher prices for customers on loans and less certain business investment, Virgin Money CEO Jayne-Anne Gadhia told analysts last month. Many of the smaller banks have focused on buy-to-let lending to landlords, a sector under close scrutiny from the Bank of England and U.K. government over fears that the market could be overheating.