UK challenger banks could compete for larger mortgage market share, Moody's says

UK challenger banks seem poised to compete with established players for larger a share of the country’s mortgage market, according to Moody’s.

In a note to clients, the agency opined that increasing competition in the mortgage market driven by the return of the incumbent banks and the gradual maturity of the Bank of England's Funding for Lending Scheme (FLS) will add pressure on the banking sector's net interest margins.

“As a result, lenders with a small deposit base or growing at a very fast rate, such as some challenger banks, could consider alternative funding options, such as securitisation, to fund new loan origination," the agency added.

Annabel Schaafsma, Managing Director of Structured Finance at Moody's, said: "Challenger banks try to gain market share from the incumbent lenders through more attractive pricing, while newly created entrants benefit from greater flexibility owing to their lack of legacy conduct issues and smaller, less costly infrastructures."

Moody’s said these institutions have attracted equity and debt investors, given their relatively positive results. “The relatively larger challenger banks, those recently independent, restructured or with significant changes in their business models, are also trying to streamline their product offering.”

As a result, the agency believes, these challenger lenders are generally more focused on specific segments of the markets where they operate. “However, all challengers are trying to respond to the negative pressure on net interest margin by increasing volumes allowing for net revenue to grow faster than costs," Moody’s added.

The agency also said that while the current list of challenger banks it observed have consumer loan exposures, the banks' portfolios of these asset types are relatively small at this point. For example, Virgin Money's total unsecured lending exposure is about 4%, while TSB's is higher at about 11%.

Furthermore, challenger banks' securitisations have remained stable, with lower-than-average losses and arrears, Moody’s concluded.