With three major US banks having collapsed this year, and markets roiled, it’s tempting to draw parallels between the current volatility we’re witnessing and 2008. The reality is that this turbulence is markedly different in origin and form to the global financial crisis, and while we’ve entered what we expect will be a prolonged period of credit tightening, we don’t need to bring the term “credit crunch” into the common lexicon just yet. These recent events are a timely reminder of the vital importance of a diversified finance market that features a mix of both bank and non-bank participants.
Banks have been retrenching from real estate, and development finance in particular, since 2008, initially in response to the immediate shockwaves triggered by the GFC and the resulting credit impairments they suffered, followed by the raft of regulatory changes and compelled institutions to give such lending activity a higher risk weighting. The extent to which non-bank lenders have effectively filled this void and become a cornerstone of a diversely funded market was underlined emphatically by the Bayes Commercial Lending Report. Debt funds and insurers together now account for 38% of new originations (24% and 14% respectively), surpassing, for the first time, UK banks and building societies, which accounted for 35% of H1 2022 origination.
It’s important to acknowledge that non-bank lending has matured considerably in the period since the GFC. By pursuing a disciplined credit underwriting and loan management approach akin to their regulated banking counterparts, firms have, in a relatively short space of time, been able to build exceptionally strong loan portfolios and significant credibility with both the capital markets and borrowers. This, combined with the fact that firms like ours can offer bespoke, highly structured financing solutions, each with a unique strategy and risk/return appetite which can be optimised for all (including challenging) market conditions, make non-bank lenders a crucial source of liquidity within the UK’s real estate market.
I expect banks will have to scale back their lending in the short term due to the increased burden of working out existing positions, and interest coverage ratios (ICRs) being harder to meet in the current interest rate environment. They will however be back in the areas they lead – relationship-based lending, revolving credit facilities (RCFs) and sustainability-linked financing, to name a few. We should take comfort that the post-GFC regulation has worked and European banks remain strong, whilst without the burden of this regulation, private markets have simultaneously been able to flourish.
I expect Precede Capital’s share of market to continue to grow year-on-year, as the Bayes Commercial Lending Report has shown for twelve consecutive years. There is a wider growth trend in private markets, and for private credit – which should be more resilient in a rising-rate environment given it generally consists of floating-rate loans. We expect to see increasing allocations from institutional LPs this year to private credit strategies, particularly those secured against real assets where valuations are resilient, giving non-bank platforms increased capacity to lend.
Precede Capital’s own pipeline remains very active with enquiries up 82% YoY for Q1-2. As always, we’re focusing down on due diligence and on our stress-testing parameters to reflect current downside risk. Sales and construction starts are undoubtedly slowing, but robust demand is being channelled into other areas. The increasingly institutionalised rental market is one particularly strong area: the last two transactions Precede closed both involved the financing of regional build-to-rent (BTR) developments.
The recent research by The Times into local councils abandoning housing delivery targets and suspending new developments, confounds the other macro issues and is a reminder that housebuilding needs strong political leadership. If we are to make up for the shortfall in new homes and address what is fast becoming a veritable national crisis, at least we can rely on a well-functioning finance market to lead the way.