UK Mid-Sized Banks Face Significant Further Credit Charges


Tuesday, May 19, 2020 / 5:54 PM / By Fitch Ratings / Header Image Credit: Telegraph


Mid-sized UK banks reported lower loan impairment charges for 1Q20 than their larger peers, increasing the risk that sizeable impairment losses in the coming quarters will weigh on their earnings amid economic fallout from the coronavirus pandemic, Fitch Ratings says.

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Based on the impairment rates assumed in the scenario published in the Bank of England's May 2020 Financial Stability Report, additional impairments due to the pandemic could total up to GBP2.5 billion across Virgin Money (BBB+/Rating Watch Negative (RWN)), The Co-operative Bank (B-/RWN), Tesco Personal Finance Group (TPFG; BBB/RWN) and Metro Bank (BB-/Negative Outlook). This would more than triple the banks' combined loan loss allowances compared with the latest reporting.


Virgin Money and The Co-operative Bank reported increased loan impairment charges for 1Q20 in common with larger banks. But the charges appear low given the likely extent of GDP contraction and increased unemployment. Fitch expects GDP to shrink by 6.3% in 2020 and unemployment to rise to 6.6%.


Other UK mid-sized banks have a more limited quarterly disclosure. TPFG recently published its annual results (based on the year to 29 February 2020), which do not yet reflect the impact of the pandemic, although it forecasts a loss for FY21, with increased impairments a key driver.


Coronavirus-specific 1Q20 impairment charges were GBP164 million for Virgin Money and GBP0.3 million for The Co-operative Bank, bringing their respective loan loss allowances to 0.7% and 0.2% of gross loans at end-March 2020. These allowances are significantly lower than the average of the five largest UK banks, which was 1.2%, and we believe that this only partly reflects their focus on low-risk and secured mortgage lending. Such lending accounted for 82% of Virgin Money's gross loans and 93% of The Co-operative Bank's gross loans at end-March 2020.


Metro Bank's much lower loan loss allowances (0.23% of gross loans at end-2019) reflects its greater focus on secured lending. TPFG's much higher pre-coronavirus loan loss allowances (5.5% of gross loans at end-February 2020) reflects its focus on unsecured lending (credit cards and personal loans).

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We expect UK mortgages to be more resilient than unsecured loans during the crisis given the job retention schemes implemented by the government, along with short-term payment holidays, low interest rates and generally conservative loan-to-value ratios in banks' mortgage portfolios. The UK regulator has guided that a loan should not automatically be classed as impaired if the borrower makes use of payment holidays, benefiting IFRS 9 impairment ratios. Coronavirus-related impairment charges will be driven mainly by business and unsecured consumer loans, although we expect that the extent of impairments will be mitigated by support measures.


Virgin Money's business and unsecured consumer loans amounted to 11% and 7% of its total loans respectively at end-March 2020. Corresponding figures for The Co-operative Bank were about 5% and 2% respectively, while all of TPFG's loan book related to unsecured consumer lending. Metro Bank's SME lending amounted to 27% of its loan book, while unsecured consumer loans were immaterial.


Most UK mid-sized banks entered the crisis with healthy asset quality and sound funding and liquidity profiles but earnings have been under pressure from strong competitive pressures and large conduct charges. We expect continued earnings pressure in 2020 due to lower base rates and an expected drop-off in new business volumes, reducing capacity to absorb higher full-year impairments.


Fitch took various rating actions on UK mid-sized banks in April 2020, reflecting these downside risks. See Fitch Takes Action on 7 Mid-Sized UK Banks on Coronavirus Outbreak.

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