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Big banks squeeze out smaller rivals in UK's ultra-competitive mortgage market

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Big banks squeeze out smaller rivals in UK's ultra-competitive mortgage market

Britain's biggest banks are competing to win a bigger slice of the country's lucrative mortgage market and smaller lenders are being forced out.

The mortgage market is dominated by the country's biggest banks with the top six providers taking a 70% share, according to U.K. Finance. Lloyds Banking Group PLC is the biggest single lender with a 20.4% slice.

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Supermarket chain Sainsbury's said Sept. 25 that its bank, Sainsbury's Bank PLC, would immediately stop new mortgage sales as part of a five-year plan to boost profitability. A decision on whether to put the £1.47 billion mortgage book up for sale is likely to take place after Brexit, said analysts at Goodbody. The bank will focus on less capital-intensive operations, such as insurance and credit cards, instead.

Sainsbury's move follows that of another supermarket-owned bank, Tesco Personal Finance PLC, which sold its £3.7 billion mortgage book to Lloyds at a slight premium of £3.8 billion earlier in September. Tesco had announced its decision to stop new mortgage lending in May, citing "challenging market conditions."

In the U.K. mortgage market, Sainsbury's Bank and Tesco Bank are small players, accounting for just 0.1% and 0.3%, respectively, of mortgages outstanding.

Margins under pressure

Andrew Montlake, managing director of independent mortgage broker Coreco, said the supermarket banks were unlikely to be the last mortgage providers to quit the market.

"The level of competition in the market is causing a major rethink among lenders for whom mortgages are a bolt-on rather than their core business. Just as with Tesco, for Sainsbury's the margins are no longer there and its mortgage division was almost certainly struggling to wash its own face," he said.

Acquiring Tesco's mortgage book tightened Lloyds' already strong grip on the U.K. residential mortgage market. Lloyds said the acquired portfolio will "generate good returns to the group in excess of current organic market opportunities."

Big banks incentivized

With the country's largest lenders already commanding the biggest share of the market, regulatory changes have given them the firepower to compete more ferociously than ever.

At the start of this year, the biggest banks were obliged to "ring-fence" their retail banking operations to separate them from their investment banking arms in a move aimed at making them less likely to collapse in the event of another financial crisis.

But this has a led to an unexpected effect, which the Bank of England has noted when it said competition in the mortgage market "may have been amplified" as a result.

"As some ring-fenced entities have more domestic deposits than loans, and are subject to restrictions on the type of banking activity they can undertake, they may be incentivized to increase mortgage lending," said the BoE in its May report on U.K. financial conditions.

The BoE said that competition in the mortgage market had been "intense" and since the start of 2018 this has been most apparent in the high loan to value segment of the market where the average quoted rate on two-year fixed 95% loan-to-value mortgages has fallen by around 80 basis points, even though reference rates had picked up slightly.

Buoyant market

Royal Bank of Scotland Group PLC's personal banking CEO, Les Matheson, recently told analysts at Jefferies that the "mortgage market is surprisingly buoyant" and the bank had recorded a spike in mortgage applications.

But in a sign of just how competitive the market is on pricing, the bank said in its half-year results that its net interest margin — the difference between what the banks pays on deposits and earns from lending — of 2.02% was 5 basis points lower than in the first quarter "primarily reflecting competitive pressures in the mortgage business."

HSBC Holdings PLC's U.K. CEO Ian Stuart said recently that the lender aimed to expand its mortgage book from £100 billion to £135 billion, so its overall share of the market increases to 10%.

The bank traditionally lagged behind its U.K. rivals in the mortgage sector as its main focus is on Asia, where it generates about 80% of its profits, but ring-fencing its operations has resulted in surplus liquidity in the U.K.

HSBC has said it is not to blame for the pressure on mortgage providers' margins. It has pointed to its relatively small share of mortgage customers on standard variable rate mortgages, about 4% in total, compared with much higher proportions at other banks. When customers on standard variable rate mortgages switch to cheaper fixed rate deals, margins come under pressure.