IFRS 9 | 4Q24 results update: the return of uncertainty?

The positive trends seen in the first half of 2024 continued in the second half with the 4Q24 results showing a further reduction in ECL cover reflecting the continued improvements in economic outlook. Post Model Adjustments (PMAs) continued to fall as a proportion of ECL, in line with subsiding inflation and normalisation of the new rates environment. 

2024 ended on a positive note: affordability improved (driven by lower cost of borrowing and real wage growth), credit performance remained robust, house prices went up, and mortgage market activity saw a slight increase. Consumer lending balances continued their slow recovery from the significant deleveraging seen in 2020.

While portfolio performance remains remarkably good given the shocks we’ve been through and, in particular, new to arrears flows for mortgages continuing to fall from their peak, there was a dramatic increase in uncertainty and drop in business confidence toward the end of 2024.  Firms’ economic scenarios at December did not show much impact from measures announced in the November budget and of course, since January, there has been a dramatic change in the wider economic and policy environment which we will comment on more in our 1Q25 blog as it was regarded as a post-balance sheet event for year-end reporting.

Our early view is that the end of 2024 saw most lenders drawing a line under inflation and affordability risks and that 2025 will be characterised by mortgage lenders resolving any remaining increases in stage 3 from refinance payment shock events, managing the first order direct impacts of the changes to employment costs and trade arrangements, and trying to understand the likely second order credit risk consequences in a constantly changing policy environment.

1. ECL cover fell over 4Q24.

ECL cover fell over each quarter of 2024 (Figure 1),  decreasing to well below 2019 levels at the year end. Bank outlook statements echoed this benign sentiment (Section 2).

ECL coverage decreased across all benchmark lenders in 4Q24, continuing the positive trend observed since the start of 2023 (Figure 3). This decrease was consistent across all main asset classes at the UK product level.

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

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

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

2. Consistent with the decrease in ECL coverage, the economic outlook continued to improve.

Banks' economic outlook brightened further at the end of 2024, as illustrated by the aggregated base case projections for our sample banks in Figure 4. 

GDP expectations continued to improve, with economic growth further stimulated by the continued loosening of restrictive monetary policy. Increased mortgage, largely driven by market pricing, corresponds to this reduction in rates. The UK labour market remains resilient, with unemployment rates hovering near historic lows and projected to increase only moderately. 

Despite a slight widening in the range of views on unemployment and the bank rate, November’s UK budget did not generate a strong response in IFRS 9 economic outlook at year-end.

Figure 4: Change in economics base case 4Q23 -> 4Q24 (min, max, mean)

3. Post Model Adjustments (PMAs) remained broadly flat during 2H24, representing a small percentage of ECL.

Inflation and sector-specific PMAs have decreased to an average of 2% of ECL, though this varies by bank. Overall, total PMAs averaged 4% at the end of 4Q24, down from 5% at 2Q24 and 9% at 4Q23. This reduction reflects a return to more normal operating conditions and a decline in the "novel" risks that models struggle to manage.

Figure 5: Post Model Adjustments as a % of total ECL (average and range)

4. UK household affordability improved due to growing real earnings and lower debt servicing costs

The affordability position continued to improve through 2H24. Quoted lending rates were lower than their peak, except for credit cards (Figure 6), payment shock was significantly reduced for mortgage customers (Figure 7), and real pay continued to recover (Figure 8).

The Nov'24 BOE Financial Stability Report indicates that while c.50% of mortgage holders will face higher borrowing costs over the next 3 years due to refinancing, 25% are expected to secure lower rates. Currently, 37% of mortgages have not been refixed since the rise in rates in late 2021, meaning the full impact is still developing. However, with continued strong income growth and low unemployment, the amount of debt held by UK households relative to their income has continued to improve. While many UK households, including renters, are still facing pressures from the increased cost of living and higher interest rates, mortgage arrears are low by historical standards and the share of households spending a high proportion of their income on mortgage payments is expected to remain low.

Figure 6: Interest rate over time

Figure 7: Payment shock on remortgage for product switches in each month

Figure 8: YoY pay growth

5. Credit performance remained strong.

Underlying credit fundamentals are strong with a slight improvement in the proportion of loans in Stage 3 at 4Q24 (Figure 9) and a continued decline in mortgage new-to-arrears levels (Figure 10).

Figure 9: Group: Stage 3 as a % of loans and advances

Figure 10: Quarterly MLAR new arrears (#k)

6. Conversely, consumer confidence and business optimism have weakened.

Despite the positive trends observed in the second half of 2024, the period leading up to the UK budget saw a fall in consumer confidence, further aggravated by heightened uncertainty surrounding UK policy changes and geopolitical risks towards the end of 2024. Business optimism has declined, although levels remain above the lows of 2020 and 2022. 

The increase in National Insurance contributions and the minimum wage are likely to have a disparate impact across UK sectors, with labour-intensive industries feeling the most pressure. Sectors such as hospitality, retail, social care, and logistics, which are typically characterised by thin margins and a reliance on lower-paid workers, may face a substantial increase in operating costs. SMEs across all sectors may encounter disproportionate challenges due to their limited financial reserves and reduced flexibility in passing on these additional costs.

Figure 11: UK Consumer Confidence and Business Optimism

7. Looking forward

In early 2025 portfolio fundamentals seem to have stayed strong but the credit environment is characterised by uncertainty and volatility.  The direct impacts of increase in employment costs will become clear over the next few months and firms are grappling with the credit risk consequences of policy and geopolitical uncertainty and volatility.  

We have been thinking about this in two phases: firstly the direct impact of employment costs and changes in trade arrangements and secondly the secondary impact through changes in the general economic outlook and consequent impact on credit drivers such as GDP and unemployment.  We see business lenders undertaking sector reviews and specific counterparty reviews to assess the credit impacts of policy changes for their larger clients while there is likely to be little direct impact on personal lending in the near-term. We will cover the first quarter’s geopolitical developments in more detail in our 1Q25 results note.

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.

References

Figure 1,2, 3, 4, 5, 9: company reports, Deloitte analysis

Figure 6, 7, 8: Bank of England quoted rates, Office of National Statistics (ONS), Deloitte analysis.

Figure 10: FCR MLAR Statistics

Figure 11: Deloitte CFO Survey, GFK