Challenger banks and building societies: outlook for lending growth

The challenger banks sector delivered strong lending growth in the past few years.

But there’s a more uncertain outlook for 2023, with the rising cost of living placing pressure on consumers and businesses.

There are still opportunities for growth though – in particular, in the residential professional buy-to-let segment and in the emerging green retrofit lending space.

Overall, lending growth is expected to be more nuanced than in previous years.

We expect subdued growth in the residential owner-occupied mortgage market due to higher mortgage rates and falling house price growth.

Total UK residential transactions decreased at the backend of 2022, and we anticipate that to continue.

Similarly, house prices data shows a slowdown in price growth towards the end of 2022. With a more subdued outlook for house purchases, product switches may become more important.

The residential buy-to-let segment will continue to be buoyed by the strong demand for rental, which is outstripping supply.

But changes in tax legislation and increased financing costs could lead to a shift in demand from amateur buy-to-let landlords to professional landlords. Forecasts indicate a 27% decrease in new lending to buy-to-let landlords.

We’re already seeing landlords increase the size of their portfolios – in 2018, 45% of landlords owned just one property; it was 43% in 2021. We expect this shift to accelerate with the professionalisation of the buy-to-let segment. 

Large corporates and private equity players remain interested in the UK residential property, with specific interest in the build-to-rent market.

We also expect demand for additional finance to make improvements if legislation is introduced to improve rental property EPC ratings, which creates further challenges for landlords.

The residential development mortgages segment is expected to be more subdued. Developers continue to face higher building costs and supply chain issues at the same time as demand for house purchases slows.

We’ve already seen a sharp fall in development finance to SMEs of 15% in October 2022 relative to October 2020.

We expect demand for retail unsecured lending – including credit cards – to increase, with inflationary pressures affecting real wage growth and consumers having to manage the increased cost of living.

New credit card flows continued to grow, passing the £1 billion mark towards the end of 2022. Repayments on credit cards declined in the latter months of 2022, indicating that a higher percentage of lending is becoming interest-bearing.

Unsecured personal loans volumes are expected to increase at a lower rate than credit cards as banks review risk appetite to manage potential delinquencies. Data shows that relative to credit card lending, other loans and advances (including car finance) have declined and not reached pre-Covid levels. 

An estimated 13.5 million UK buyers are using buy-now-pay-later (BNPL) schemes, especially among younger demographics (25-34 years).

We expect high volume growth in this category as it’s currently easily accessible to consumers.

Potential regulation is currently being discussed in the UK, which may impact how risk is assessed and priced for this segment.

We‘re likely to see higher demand for SME lending as businesses increasingly look for credit to manage cash flows.

Term loans, overdrafts and revolving lines of credit are expected to see the highest growth rates.

The latest figures show that monthly overdraft balances of SMEs exhibited growth in each month of 2022 compared to the same month last year (Bank of England, table RPMZ8YE). The increase was driven by SMEs in energy and utilities sectors seeking short-term liquidity to manage high price volatility.

Lenders may start to tighten their risk appetite for issuance of new lines of credit. That’s not showing up yet at a level experienced during the Great Financial Crisis due to relatively high levels of liquidity across the market.