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For British bank start-up, Brexit has silver lining: more loans

[October 25, 2016] By Guy Faulconbridge and Sinead Cruise

LONDON (Reuters) - Rishi Khosla didn't vote for Brexit, but he says it has proven a boon for his new start-up bank.

OakNorth was just nine months old, with a new loan book of 100 million pounds, when Britain voted in June to leave the European Union.

As sterling and stocks around the world tumbled in the hours after the vote, he gathered his staff to go over every loan in the book and in the pipeline. They decided to tweak the terms of just two deals -- and, instead of retreating, keep lending.

Since then, OakNorth has doubled its loan book to 200 million pounds, with another 60 million awaiting final approval.

"Brexit is something that has actually had a massively positive impact on the business," Khosla, chief executive officer of OakNorth, told Reuters at his offices in London's Mayfair area. Thanks in part to the surge in business, his new bank broke even in August, seven months earlier than expected.

The conventional wisdom is that leaving the European Union, by hurting Britain's economy, will doubly hurt its banks, and that small banks with potentially greater exposure to weaker loans will be hurt more than big ones.

But for some in the tiny but rapidly growing sector of start-ups known as "challenger banks", Brexit could offer more opportunities to find business. If tightening conditions force big banks to retreat from lending, smaller banks may have a bigger role to play.

"The big banks are very constrained in what they can do. Yes, they have cheap funding but they also need to get loans through model-driven credit approval processes," Khosla said.

"They don’t have people in branches making credit decisions anymore. You throw it into a computer program and it gives you a green light or not. But we have people making those decisions."

Britain's start-up challenger banks were born after the 2008 financial crisis, when the Bank of England lowered the capital requirements to set up new banks. Since then, the upstarts have yet to be tested by a major economic crisis, and some analysts who study the sector have been pessimistic.

"The impact of the EU referendum result- slower volumes, delayed operating leverage, lower margins, asset quality issues- are likely to be more pronounced in the Challenger Bank sector than the incumbents," Citi said in a recent note.

Share prices at some of the largest start-up lenders have been hit badly in 2016, despite strong first-half lending and deposit growth at the likes of Virgin Money, Shawbrook, Aldermore and newly-listed Metro Bank.

Nevertheless, British banks are still busy writing loans. While the outlook for Britain's housing market remains uncertain, data published on Thursday by the Council of Mortgage Lenders estimated gross lending of 63.6 billion pounds in the third quarter of the year, up 11 percent on the previous quarter and up 4 percent on the corresponding period in 2015.

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EXPANDING

Most of Britain's small banks are publicly listed and therefore restricted from revealing how their balance sheets have fared since the Brexit vote until they release their third quarter results, which are due in coming days. But before the vote they were growing fast.

Metro Bank more than doubled the size of its loan book in the year to June 30, to 4.6 billion pounds from 2.2 billion. Shawbrook's net loan growth for the first half of 253 million pounds was up 28 percent annualized.

Aldermore reported 21 percent growth in lending on an annualized basis in the first half of the year. It cut savings rates for the second time in seven months in October, as deposit growth surged faster than it could find lending opportunities.

For institutional fund managers, representing hundreds of millions of pounds in potential investment in the sector, the main concern is that start-up banks can achieve meaningful business or mortgage lending growth only by taking on risky borrowers shunned by more established lenders.

Khosla at OakNorth acknowledges that keeping a tight grip on credit risk is “the most important thing” for a new entrant, but denies the model automatically requires taking excessive risk. He describes his clients as established borrowers, "people who have actually built a business and who are now looking to scale that business".

“We don’t lend to start-ups. These are midmarket companies with revenues of 10-100 million pounds,” he said. As an example, he says OakNorth loaned 19 million pound to Leon, a growing fast-food chain with dozens of restaurants, shortly after the Brexit vote.

Still, investing in the small bank sector is mostly a highly-leveraged bet on the fundamentals of the British economy, analysts at Barclays said in a note earlier this month, although they said "comfortable capital ratios and low valuation multiples should provide significant insulation”.

Khosla, 41, a former investment banker who worked at ABN Amro, GE Capital and the venture capital businesses of steel baron Lakshmi Mittal, still expects Brexit to damage the British economy. But he does not think that will kill off small banks.

"There is a high probability that the UK will go into a recession. Do I think the economy will stop? No. The economy will still run. It will still turn so there will still be opportunities."

(Editing by Peter Graff)

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