IFRS 9 | 1Q25 results update: Uncertainty takes centre stage

1Q25 has certainly been eventful, marked by a significant shift in the economic and geopolitical landscape. This has shaken market confidence and created uncertainty for businesses. While the media coverage on the economy has been, at times, dramatic, the Expected Credit Loss (ECL) response from UK banks was comparatively restrained at 1Q25, with broadly flat ECL cover over the quarter bringing the trend of reductions seen since 2Q23 to an end.  Correspondingly, firms made only small changes to their economic outlooks.

Although disclosure is more limited at 1Q, banks’ reporting indicated no meaningful change in Post Model Adjustments (PMAs), with no sign of banks resorting to them to manage the novel risks arising from the current environment. While some lenders implemented minor PMAs, others deemed their existing "uncertainty" PMAs sufficient to cover the evolving risk landscape.

Despite lower business optimism and heightened uncertainty, portfolio performance remained strong, supported by improving affordability dynamics. Mortgage credit performance continued its positive trend, with new to arrears flow down from its recent peak and back at 2019-levels.

Focus has shifted to sector and counterparty reviews to assess potential credit risk impacts from rising workforce costs and potential trade arrangement changes. Credit teams describe near-constant revisions to their tariff strategies as the situation has continuously evolved since the April announcement! 

The banks in our sample had benign outlook statements for the rest of the year, with no expectation of elevated credit losses.  But the environment feels febrile with elevated uncertainty metrics and it is not clear how recent events will flow through loan portfolios.  As we seem to say so often, time will tell…

1. ECL cover broadly flat at 1Q25.
 

The first quarter of 2025 was marked by a late surge in uncertainty and geopolitical risk. Despite alarming headlines on the economy, UK banks maintained a relatively calm stance, with broadly flat ECL key metrics (1bp increase in ECL cover) and a broadly stable view of credit risk.

That being said, this quarter marked the first time since 4Q22 that all the banks in our sample either maintained or increased coverage levels (Figure 3), breaking a long run of decreasing cover.

Figure 1: ECL cover (ECL / Loans and advances)

Source: Company reports, Deloitte analysis.

Figure 2: ECL cost of risk (annualised P&L charge / loans and advances)

Source: Company reports, Deloitte analysis.

Figure 3: QoQ Change in ECL cover mean and range (bp)

Source: Company reports, Deloitte analysis.

2. Despite the newspaper headlines the base case economic outlook was broadly flat.

There was a mixed approach across the banks with respect to updating the economic outlook for 1Q25, with some opting to adjust scenario weightings downwards and reflect a mild deterioration in outlook, and others maintaining the same economic forecast and weightings as 4Q24 with changes expected at 2Q25. 

Mirroring the relatively stable ECL coverage, the base-case economic outlook remained broadly flat across HPI, Unemployment and Bank Rate but there was some deterioration in UK GDP expectations (Figure 4).

Figure 4: Change in economics base case 4Q23 -> 1Q25  (min, max, mean)

Source: Company reports, Deloitte analysis.

3. Increased uncertainty and market volatility.

Global stock markets reacted sharply to the initial tariff announcement (Figure 5), and while there was a significant recovery with the “pause”, uncertainty persists regarding long-term trade policy and the economic outlook.

The impacts of the heightened uncertainty can be seen in the Policy Uncertainty Index (Figure 6), a measure of policy-related economic uncertainty in the UK, which has now eclipsed the Liz Truss “Mini Budget” levels.

Figure 5: Global Stock Market Performance

Source: S&P Capital IQ

Figure 6: UK Economic Policy Uncertainty Index

Source: policyuncertainty.com

4. Credit performance remained stable and strong.

All banks in our 1Q25 sample reported resilient asset quality with the proportion of loans in Stage 3 remaining stable (Figure 7).

However, some concerns remain regarding the outlook, with credit officers expressing nervousness about the impact of changing employment costs and the potential credit impact of trade policy changes (see Section 6 for more details).

Figure 7: Group Stage 3 as a % of loans and advances

Source: Company reports, Deloitte analysis.

5. Navigating uncertainty and sector specific challenges.

Adjustments to National Insurance and the minimum wage are expected to increase employment costs, particularly for labour-intensive sectors. This could lead to profitability squeeze and increased credit risk for some counterparties.  Other sectors face potential risks from both ongoing and potential changes to US trade arrangements. 

Figure 8 shows the sectors with the highest workforce contributions relative to their contribution to the UK economy, with potential risk “hot spots” in the hospitality, health and social care and agriculture sectors. As stated in our previous blog, some SMEs may feel the squeeze of rising labour costs, with margins being eroded and limited pricing power to pass costs on to consumers.

Figure 8: Sectoral contributions to jobs v's 2023 GVA (%)* 

Source: ONS 2023 GVA, ONS jobs by industry March 2024, Deloitte analysis. Note Real estate was the largest individual industry accounting for 13.1% of GVA. However, most of this is the value of “imputed rents” which is a hypothetical estimate of what owner-occupiers would pay if they rented rather than owned their homes and not output generated by the industry and so has been excluded from the analysis.
*Metric calculation: Sectoral contributions to jobs (%)/ Sectoral contributions to 2023 GVA (%) - 1

Changes to US trade policy and the associated tariffs could potentially have a direct impact on profitability of some counterparties in sectors such as machinery and transportation, chemicals and pharmaceuticals, and miscellaneous manufacturers. 

Figure 9 highlights the industries which have both a significant value and high proportion of overall exports  to the US, with chemicals, manufacturing and machinery and transport being the most exposed.

Figure 9: Trade in goods and services with the United States by commodity type, imports and exports in 2024

Source: ONS: UK Trade with the US 2024

Our conversations with lenders tell a story of almost continuous re-writing of tariff playbooks as the situation has evolved since the initial announcement at the start of April.  The situation is fluid but, whilst it sounds dramatic, UK banks’ ECL reaction has been muted suggesting limited direct initial impact concentrated on a few specific large, international corporates. Figure 10 provides a high-level view of the differing responses across portfolios.

The unknown factor is if the uncertainty translates into a wider economic chill with a broader credit risk impact, including on retail lending if it affects the labour market.

Figure 10: The impact of US trade policy on ECL

Source: Deloitte analysis

Beyond the challenges already discussed, several sectors face headwinds from various other factors, including rising costs, supply chain disruptions, climate change, insolvencies, falling demand, and increased competition. These pressures, which further squeeze profit margins, notably affect agriculture, utilities (especially water), education, and telecommunications & media.

6. The evolution of mortgage underwriting controls and the impact on credit risk.

We were interested in the FCA’s recently published consultation suggesting changes to mortgage underwriting rules. Their aim is to simplify responsible lending and advice rules for mortgages, to enhance access to homeownership and promote economic growth.

After the sins of the late “naughties”, the post- GFC focus on tighter prudential and conduct regulation has largely held for the last 15 years with some more recent relaxation, such as help-to-buy schemes, Covid-19 payment deferrals, and the FPC’s withdrawal of mortgage market affordability stress testing.  The consultation is the next step in this trend to seek the right balance between risk and growth.

Figure 11 shows the long-term trend for mortgage arrears against the economic and regulatory cycle.  The resilience of mortgage portfolios over the last couple of years has been remarkable given the significant affordability shock experienced by borrowers (albeit there wasn’t much change in unemployment).  It will be interesting to see where the position lands on the “right” level of risk and the balance with good customer outcomes.

Figure 11: Long-term UK Mortgages Arrears and Possessions as Proportion of Total Outstanding Balances at Period End

Source: UK Finance, BOE, FCA, PRA

7. Looking forward.

At 1Q25 portfolio fundamentals remained strong with affordability dynamics improving. UK banks' key ECL metrics were broadly stable and the banks issued fairly benign ECL cost-of-risk outlook statements. This calm is notable given current heightened market uncertainty and volatility!

However, the outlook feels opaque and uncertain with risks from increasing employment costs, trade arrangements, geopolitical tensions, and the potential for a downward confidence spiral leading to broader economic and credit impacts.  

We hope that the mists will clear somewhat as we head toward half-year reporting!

Looking ahead to the rest of 2025, more technical areas of focus include:

• For IRB firms: coping with the downstream model changes to IFRS 9 from regulatory capital model change programmes.
• Improving practices for setting and monitoring quantitative PD SICR thresholds: Regulators maintain their focus on the consistent application of IFRS 9 staging across the industry. 
• Model calibration, particularly for LGD, given the challenges posed by the scarcity of reliable historical data for certain portfolios given their typical long outcome periods.
• Further improvements to how lenders consider the effects of climate risk in their IFRS 9 processes.

We hope you found this quarterly assessment useful. You can find previous blogs in this series below. Alternatively, please don’t hesitate to contact one of our team who will be happy to discuss any of the topics covered here with you.