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Post European Referendum: Challenger Banks Digest



Membership of the EU and its predecessors has long been a topic of debate in the UK. The UK joined the European Economic Community (EEC, or "Common Market") in 1973. A referendum on continued EEC membership was held in 1975, and it was approved by 67% of voters.


In accordance with a Conservative Party manifesto commitment, the legal basis for a new referendum was established by the UK Parliament through the European Union Referendum Act 2015. The referendum of whether the UK should remain a member of the European Union, was held on the 23rd June 2016. This resulted in a “leave” majority vote.



What was the immediate impact?


Financial markets reacted negatively in the immediate aftermath of the result. Investors in worldwide stock markets lost more than the equivalent of $2 trillion on 24th June 2016, making it the worst single-day loss in history, in absolute terms. The market losses amounted to $3 trillion US dollars by 27th June. The value of the pound sterlingagainst the US dollar fell to a 31-year low. The UK's and the EU's sovereign debtcredit ratingwas also lowered byStandard & Poor's.


By the 29th June, UK markets had returned to growth and the value of the pound began to rise.



So how did this effect the UK Challenger Banks?


A Challenger Bank offers customers in the UK an alternative choice of banking arrangements, many attempting to differentiate themselves with value services and improvements in service quality. The changes to both the regulatory environment and deregulation in the banking market has enabled Challenger Banks to enter the market through a greatly simplified process and one that has also reduced the initial capital outlay requirement.


Challenger Banks are simplifying the financial world, creating a customer centric approach to service, transforming the way banking is viewed by the public and the market. In return they hope to deliver larger returns on equity compared to those of the larger banks. In addition to this, they strive to offer greater flexibility when it comes to lending, through streamlined operations and lower costs.


Despite economists and “Remainers” painting a doom and gloom EU Referendum “leave” picture, nothing has changed in terms of Britain's banking giants and the threat posed to them by the Challenger Banks. Challenger Banks have not only weathered the referendum storm but on the contrary are bathing in the outcome and continue to disrupt the UK banking sector.


Challenger Banks are investing heavily in new technology, with the UK seen as a leader in the Global FinTec market, supporting new and innovative initiatives. This coupled with a backdrop of a weakened pound, has furthermore encouraged foreign investors as seeing the UK as an attractive investment opportunity, one providing entry into a lucrative and expanding challenger banking sector.


As of September 2016, thirty new Challenger Bank applicants have held discussions with the PRA and FCA, compared to a year ago where there were sixteen. At present, four of those applicants are halfway through the process of applying for a banking licence which would allow them to offer products such as loans, savings and current accounts.


It seems unavoidable that the banking giants will lose many customers, driven by the pressures of leaving the EU, which will force them to cut back on innovation. This will allow the leaner Challenger Banks to make significant inroads into their businesses. The threat of those banking giants moving operations abroad, such as HSBC, could also contribute to the acceleration of Challenger Banks growth and success, as they swoop in and temp customers with their UK centric and transparent banking services.


Since the EU Referendum, OneSavings Plc, Aldermore Group Plc, Shawbrook Group Plc and Metro Bank Plc share prices have largely recovered since they were shocked in June of this year, with strong formal uptrends seen in all three cases. The negativity displayed pre and post the EU Referendum, has not hurt Challenger Banks nor the markets as much as previously anticipated. This has resulted in growing optimism in the UK.


Prior to the June 2016 vote, the market expressed concern that a EU Referendum may spark an economic slowdown in the UK. This provided the Challenger Banks with their first real test of sustainability and USP creditability, as they faced a real threat of potentially stalling growth, driven by the risk of their loans souring.


Since the vote, a number of Challenger Banks have been very vocal in their belief that the outcome of the EU Referendum is in fact an opportunity to gain a larger market share from larger rivals who are retrenching amid the uncertainty. UK Challenger Banks also have the advantage of being immune from the fluctuations in the pound, which will preclude them from the detrimental impacts on growth and bottle line, currently effecting the banking giants whom are exposed to multicurrency operations.


Since June, OneSavings Bank has the strongest performance since the bank was taken public by JC Flowers & Co. in June 2014. Aldermore (backed by Anacap Financial Partners and Toscafund Asset Management), and Shawbrook (backed by British Business Bank Investments) share prices have also both risen after an analyst upgrade. All three lenders’ share prices have bounced back to 320p, 198p, and 260p, respectively, which are very close to where they traded before the EU Referendum, five months ago.


In addition to Shawbrook’s share price, the bank saw £1.5 billion of new loans written in Q3 of 2016 despite the usual slowdown in the property market and the EU referendum. The bank’s loan book at the end of September 2016 was up 19% year to date, to over £4 billion. This was largely driven by its property finance business, which achieved a record level of originations.


Metro Bank’s share price has demonstrated an even more robust stance, by trading in excess of 50% above the share price in June 2016. The bank has shrugged off the EU Referendumto win more customers and boost lending, taking it to the cusp of reporting its first profit. It appears the bank has felt no impact from the vote to leave the European Union. During this time Metro Bank’s deposits have jumped 66% to £7.3 billion compared with a year earlier and lending climbed by 73% to £5.2 billion. This has seen its first ever underlying pre-tax profit of £567,000. Metro Bank is still very small when compared to high-street giants, but despite the vote, the  is growing rapidly, and its appeal with customers will continue to drive growth. If the bank hits its target of £50 billion in deposits, it's likely its shares could double or even triple from the current levels.  


TSB, owned by Spanish banking group Sabadell, has also enjoyed a jump in profits as it continues to attract customers undaunted by the EU Referendum. Profits at TSB more than trebled to £161.6 million in the nine months to the 30th September 2016, compared with £49.1 million in the same period a year earlier. Customer deposits have swelled by 11.9% to £29 billion since the end of December, while the bank’s lending was up 8.5% to £28.6 billion over the same period. This suggests that UK consumers have taken the referendum vote in their stride,together with TSB’s Spanish owner announcing they were undeterred by June’s UK vote to leave the EU.


Since June, Atom has been ranked as one of the world’s leading innovators in financial technology in a recent KPMG study, for the second year running. The bank, which launched in April, has also not been deterred by the EU Referendum and since the vote has provided a substantial undisclosed commercial loan to Rivergreen Management Pension Fund. This funding will be used to acquire a long lease of an industrial property in Hartlepool. The loan has also allowed the fund to increase its presence at the Rivergreen Business Park in Queens Meadow Hartlepool by extending its ownership to three industrial units in total.  


Virgin Money also joins a host of other lenders, who have confounded expectations that Challenger Banks would be hurt by the uncertainty amongst their consumer and business customers after the vote. The bank has also brushed aside concerns the EU Referendum has rocked the banking sector, with their share pricing also bouncing back, despite imposing tighter restrictions on credit cards. Virgin’s net mortgage lending jumped 33% to £3.5 billion between the end of 2015 and 30thSeptember 2016. This represents a record quarter for the bank, despite the vote in that quarter.


OakNorth Bank since the referendum is another testament to the strength of the UK Challenger Bank sector, by revealing it has broken even and inched into profitability, less than a year after the bank first began taking deposits and lending.  Oaknorth has furthermore waved away the sector's EU Referendum concerns by revealing it had closed over £100 million in debt finance deals since the vote and doubled its loan book to over £200 million. This includes a £19 million deal with restaurant chain Leon.


The EU Referendum has also not deterred new Challenger Bank entrances from completing their licencing applications and periods of AWR (authorised with restrictions), to opening their doors, such as Tandem, Starling, and more recently Redwood, Amicus and Hampshire Community Bank. Masthaven, the bridge financing specialist, is also preparing to launch within the next few weeks.



What’s next?


For the UK to leave the EU, it will be required to invoke an agreement called Article 50 of the Lisbon Treaty which will give the UK and EU two years to agree the terms of the split. Theresa May has said she intends to trigger this process by the end of March 2017, meaning the UK will be expected to have left by the summer of 2019, depending on the precise timetable agreed during the negotiations.



What does this mean to the UK Financial Services Sector?


Currently, UK banks and financial regulated businesses are able to provide a range of financial services anywhere in the EU and in the wider European Economic Area (EEA). This is whilst being based in the UK and regulated by UK authorities. These banks and businesses have ‘passporting’ rights which allows them to offer financial services to the rest of the EEA (28 EU members plus Norway, Iceland and Lichtenstein) while only having to follow one set of regulations.


Banks and businesses can do this either by offering their services under an ‘establishment’ passport which allows them to set-up branches in EEA countries, or by offering services remotely across borders under a ‘services’ passport.


As with most discussions about the UK post-referendum, the question arises “what happens to passporting rights and how it will impact on UK financial services?”.


Passporting rights are part of an EEA agreement, any EU exit where the UK remained in or re-joined the EEA would see no impact on the right of banks and businesses to operate across EEA countries as they currently do.


If the UK leaves the EU without retaining EEA membership then there are two options:


  1. 1.      Bilateral Agreements
  2. 2.      No Agreements



As the UK is a significant provider of financial services there is a good chance that agreements will be reached. This is based upon, London’s status as a global financial centre, its influence in helping to set financial regulation globally, and the fact it is currently compliant with all EU directives on financial services. This makes it highly likely that the UK is in a better position to reach an agreement so EU businesses can continue to retain access to the UK’s financial services.


That said, one could also argue that as the UK is a net exporter of Financial Services, there could be less of an incentive for EU countries to reach an agreement with the UK. Without an agreement it will reduce competition for other EU countries financial services sectors. Should this unlikely event occur and the UK leaves the EU without a passporting arrangement, the question arises as to what would the impact be to the banks, more specifically to UK Challenger Banks?


The withdrawal of passporting, is likely to cause more pain for the foreign banks than for those UK banks wanting to offer services across the EEA. The UK banking licence is a valuable and prestigious asset, one that takes time and resources to obtain. Foreign banks will be forced to enter into ta long, expensive and difficult licencing process to remain in the UK banking network. Whilst this process is in play, UK Challenger Banks would be provided with the opportunity to swoop down and scoop up foreign customers in the UK, by offering immediate customer centric and transparent banking services, especially to the new foreign money attracted to the UK by the weakened pound.





In conclusion, once Article 50 is triggered, the UK will enter into unknown territory. However, the post EU Referendum continued growth and sustainability of the new and more established Challenger Banks, would suggest that there has been a kneejerk reaction after the vote in June. The market incorrectly priced in impairment and lower loan-growth expectations, but a revision of these suppositions has clearly rebalanced the share prices to reflect a more accurate economic outcome, defying warnings that uncertainty around the EU referendum would harm the UK Challenger Banks.


Should passporting be withdrawn from the UK, those UK banks wanting to offer banking services in Europe, will not be faced with the same issues as those foreign banks wanting to offer banking services in the UK. They will be able to obtain a licence via an eastern European quick and easy diluted licencing route. That said, offering European banking services does not appear to be on the majority of the Challenger Banks agenda at present.


The EU has always been envious of London as a thriving and well-respected financial services centre. Frankfurt, Paris, Amsterdam and Dublin are all significant financial centres, albeit far smaller than London and will be watching to see if they can make inroads, once Article 50 has been triggered.




  • Will Banks

  • Executive Director

  • Challenger Capital

  • November 2016