A new landscape Challenger banking annual results May 2016 kpmg.com/uk/banking The Challenger landscape Digitally Focused Challengers The Digitally Focused Challengers are the newest additions to the Challenger landscape, each offering the promise of personalisation and of course technology, as key differentiators. The Digitally Focused Challengers also intend to partner with other businesses and some have Atom Fidor Bank even used customer crowdfunding to further their expansion. RBS Santander Mondo Starling Tandem TSB Clydesdale HSBC Barclays Lloyds Paragon AIB UK First Direct† Bank of Williams & Glyn Ireland UK† † OneSavings Secure Trust Charter Savings Bank Virgin Money Sainsbury’s Nationwide*† M&S Shawbrook Metro Aldermore Handelsbanken Aldermore Asda Money Close Brothers Tesco The Big Five Larger Smaller Large Challengers Challengers Retailers The high street is led by a small group of retail The Larger Challengers are typically longer The Smaller Challengers have typically been The large existing retailers have entered the financial banks along with mutuals, where Nationwide is the established. Two of them are relatively new in incorporated in the past five to ten years and were services market offering unsecured products and dominant player. Throughout the report, the ‘Big terms of branding, but have inherited relatively large backed by private equity through their initial growth savings accounts. Tesco and M&S have expanded their Five’ banks referred to are HSBC, Barclays Bank, portfolios of loans and advances to customers. phase. Five of them are listed banks. offering with products such as current accounts and Lloyds Bank, The Royal Bank of Scotland and the mortgages, thus further challenging the big banks. UK subsidiary of Santander. *Nationwide is one of the largest providers of mortgages in the UK, but considers itself a Challenger in terms of current accounts. † Data for Nationwide, First Direct, Bank of Ireland UK and Charter Savings are not included in our analysis. © 2016 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Highlights The Challengers outperform the Big Five in terms of return on equity The Challengers continue On average, the The Challengers’ simple (ROE) (Big Five 4.6%, Smaller Challengers to grow in a shrinking Challengers offer the business models provide market (lending assets best rates for savers a cost advantage (cost 17.0%, Larger Challengers 9.5%) have increased by 31.5% (easy access rates: as a percentage of compared to a decline of Smaller Challengers income for the Smaller 4.9% for the Big Five) 108bps, Larger Challengers decreased Challengers 73bps, from 52.1% in 2014 to Big Five 36bps) 48.5% in 2015) Results Insights Changes in the buy- to-let (BTL)sector Digitally Focused may hinder future Challengers plan Simpler business profitability for many to distinguish Customer models allow the Challengers themselves through inertia remains Challengers to be transparency and a battle for the more competitive superior data analytics Challengers, than the Big Five particularly in the current account market © 2016 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2016 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member Challenger banking annual results | 3 firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. A new landscape The rise of the Challengers continues After the excitement of last year’s initial public offerings, the 2015 reporting season has seen the Challenger sector continue its relentless growth. Balance sheets have continued to expand, with lending assets for the Challengers increasing by 31.5 percent compared to a decline of 4.9 percent for the Big Five UK retail banks: Barclays, HSBC, Lloyd’s Banking Group, Royal Bank of Scotland and Santander. “In 2015 and 2016 a new For many of the Challengers, this growth has also resulted in improvements in profitability. Total profits for breed of Challengers the Challengers increased by £194m against a drop of £5.6bn for the Big Five (pre-tax figures). have emerged – the In the group we categorise as “Smaller Challengers”, the Digitally Focused average returns on equity (ROE)1 reached an impressive 17.0 percent2 (against 15.8% in 2014), which contrasts Challengers such as with a 4.6 percent average ROE for the Big Five. Atom, Fidor Bank, The “Larger Challengers” (excluding Clydesdale)3 have also improved returns with an average ROE of Mondo and Starling” 9.5 percent (against 8.8% in 2014). The Challenger landscape remains diverse, with many different business models between the participants. In 2015 and 2016 a new breed of Challengers have emerged – the Digitally Focused Challengers such as Atom, Fidor Bank, Mondo and Starling. We discuss the impact these might have on the market in a later section of this report. Lending assets 2014–2015 31.5% Big Five Challenger -4.9% banks © 2016 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. What is driving this outperformance? A splash of colour in 2016 As we noted last year, established thinking would In last year’s report we focused on how the Challengers have us believe that cost advantage is driven by scale. are seeking to be different, either through differentiation However, in banking this is only true in part, as with driven by resources (the things a bank has available to scale also comes complexity. The scale benefits that it) or the capabilities they have (how those things are should be gained by the Big Five have been partly deployed). These continue to be relevant. eroded by unwieldy legacy IT systems, compliance issues, regulatory change and costly real estate. So in For 2016, we have focused on two further specific 2015, as in 2014, despite being significantly smaller, aspects highly relevant to the maturing business the Challengers have outperformed the Big Five on models: costs, with an average cost-to-income (CTI) ratio of margin improvement through management 59.6 percent (excluding Clydesdale) compared to 80.6 of cost of funding (and how the Challengers percent. However as we have said before, this crude suffer from higher funding costs) measure oversimplifies a complex picture: if we exclude conduct-related costs the differential is much smaller the potential impacts from changes to the (63.4% CTI ratio for the Big Five in 2015). Buy-to-Let market, a core area of lending for many of the participants Reasons for outperformance Less complex IT systems Simpler product set ”Challengers are seeking to be different, either through differentiation driven Minor regulatory changes Less costly real estate by resources ... or the capabilities they have” More streamlined and Fewer legacy automated operating models compliance issues The Smaller Challengers produced a CTI ratio of just 48.5 percent in 2015 (against 52.1% in 2014, both excluding Metro Bank), which is significantly better than 1. Pre-tax return on tangible equity. the market, while the Larger Challengers track much 2. Excludes AIB UK as equity not disclosed. more closely to the market. 3. Clydesdale excluded as loss-making. Williams & Glyn and Handelsbanken excluded as equity not disclosed. © 2016 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member Challenger banking annual results | 5 firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Financial results 2015 saw the Smaller Challengers build on their The strong performance of the Challenger sector strong profitability metrics from 2014, while the Larger continues to reflect higher net interest margins (NIM) Challengers used their strong capital bases as a than the Big Five. The Smaller Challengers, which platform for growth. As a sector, Challenger banks are are generally focused on niche lending, reported an testing the concept that big is beautiful. One might ask average net interest margin of 4.2 percent. The Larger whether the classic economies of scale argument holds Challengers, who are more focused on residential true in banking, and that the simple business models mortgage lending, reported an average NIM of 2.3 of the Challengers put them in a stronger position to percent. compete. Competition may provide headwinds to Profitability metrics strong and getting future margin growth stronger Most of the Smaller Challengers have based their 2015 has seen continued improvements in return on business models on targeting profitable lending niches tangible equity across the Challenger bank sector, with within the UK banking market, which has delivered both Larger and Smaller Challengers improving their impressive gross yield figures. However it appears average ROE to 9.5 percent, (excluding Clydesdale) and that competition within these niches is beginning to 17.0 percent respectively (versus 8.8% and 15.8% in intensify, with the Smaller Challengers seeing a small 2014). On average, Challengers continue to significantly decline in gross yield