The Corporate Victims of Britain's Back Door Rate Hikes

(Bloomberg Gadfly) -- U.K. officials talk increasingly about the risks facing the economy as Brexit nears. But moves to tighten credit conditions through the back door will create headwinds for rebalancing important sectors of the economy, such as challenger banks and homebuilders.

The Bank of England will wind down its Term Funding Scheme by February. This measure, introduced in the wake of the referendum, was intended to help lenders pass on the benefits of low rates to their customers by providing billions in cheap cash. As the program is only open for new lending this favors banks working to increase their loan books, providing a (nearly) free funding lunch for alternatives to high street giants such as Lloyds Bank Plc.

They've flocked to take advantage, with 55 billion pounds ($71.8 billion) of usage so far. The government will raise the ceiling by a further 15 billion pounds, and that has softened the blow so the net effect on challenger bank shares is broadly neutral. But the mood music is changing and this may not have sunk in for investors.

Taking away the punchbowl is going to un-level the playing field. One of the prominent challengers, Metro Bank Plc, takes 23 percent of its base stock of loans funding through the TFS, according to Macquarie research.

They will stuff their pockets further while they still can, but net interest margins will inevitably suffer as they replace maturing liabilities.

These firms will be forced into paying higher rates to attract more deposits, or raising money on the wholesale funding market. Here, the spread charged for small banks will be considerably more than 25 basis points the TFS costs, as most are too small to warrant a credit rating.

These higher costs will have to feed through to lending rates, reducing their market share. This runs contrary to the government aims of increasing financial competition and tackling the affordability problem of the housing market.

So it's also bad timing for aspiring British homeowners. A report Friday in Property Week suggested the government may bring forward the end date (currently 2021) of "Help to Buy," its program to make new property more affordable for those at the bottom of the ladder.

The government said in a statement on Monday it's committed to the program -- but whether it remains committed in its current form is open to question. It really shouldn't be.

It supports about 38 percent of new house sales. But 20 percent of participants are using it to buy larger homes, and there's a 600,000 pound upper limit, according to analysts from Liberum. From this perspective, it gives help to those who are far from needy. 

The house builders are lobbying for HTB to be tapered rather than turned off suddenly, and for clarity on whether it will be extended in some revised format. Due to onerous U.K. planning laws the cycle for new construction is often as long as four years -- builders need to plan now for investing in new sites. 

The share prices of the builders most dependent on HTB dropped on average 3 percent after the report. Persimmon Plc has was down 4 percent Friday, as over half of its sales are financed through the plan. Both recovered only slightly on Monday.

Challenger banks have drunk long and hard at the fountain of easy credit. Their equity performance has been strong, but now that the training wheels are coming off the shares are facing some serious hurdles. And while extending HTB and continuing to fuel the housing boom creates economic risks and political costs, so pulling it back threatens to squeeze the most vulnerable, all while creating uncertainty for homebuilders. Not great, given that Brexit's on it's way.

There are always hidden consequences to clamping down on credit and introducing rate hikes by another name. Challenger banks and Help to Buy homebuilders will be the corporate collateral damage.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

To contact the author of this story: Marcus Ashworth in London at mashworth4@bloomberg.net.

To contact the editor responsible for this story: Jennifer Ryan at jryan13@bloomberg.net.