Bank lending: BoE fuels mortgage, not corporate, lending
FFL scheme cannibalizes ABS; SME lending remains elusive
The stimulation of bank lending to UK corporates has long been the ambition of the UK Treasury. In 2011 its much-trumpeted Project Merlin scheme, which was designed to set UK banks targets for SME lending, was written off as a failure when all five main UK banks missed their lending targets and their total net lending fell in all four quarters of the year. Net lending by UK banks and building societies then decreased by £9 billion in the three months to February 2012 (when the net monthly flow of lending was at its lowest in two years) and by £3 billion in the following three months to May.
The pull-back of the banks from some sectors has been dramatic. Survey data cited by Legal & General show commercial real-estate lending is back to levels of more than a decade ago. More than 50% of loan origination is concentrated in just six lenders and deals above £100 million ($158 million) have more than halved since 2007, reflecting the seizure in the securitization markets.
That is why the Bank of England (BoE) and HM Treasury launched the Funding for Lending (FFL) scheme in July, which is aimed at incentivizing banks and building societies to lend by allowing them to borrow at below market rates. Some 13 banks had applied for £60 billion under the scheme by October.
However, schemes such as this can have unintended consequences. By offering such cheap funding to UK banks, the BoE is at risk of choking off the one part of the securitization market that has successfully recovered since the financial crisis: UK prime residential mortgage-backed securities (RMBS).
This was made starkly apparent when one UK lender, Leeds Building Society, decided to retain its debut RMBS, Albion No.1, one month later.
The way the FFL scheme works is for banks to pledge eligible collateral with the BoE for four years, in return for liquid gilts at 25 basis points. These are then repoed to raise cheap funding for customer loans. So, it was cheaper for the building society to retain its RMBS issue to use it as collateral against the BoE’s scheme rather than issue in the public markets. The deal was £897 million in size and arranged by HSBC and JPMorgan.
Interestingly, another lender, the Yorkshire Building Society, chose to go ahead with a public deal in September and was marketing the trade as Euromoney went to press. It is understood to involve a £500 million public tranche and £500 million retained notes. This deal is being arranged by JPMorgan, Barclays and Deutsche Bank. However, the issuer has made it clear that the public issue is primarily a public-relations exercise – it would be cheaper to fund via the BoE’s scheme.
"Funding for Lending is direct competition for ABS," one UK investor tells Euromoney. "Issuance levels in UK ABS will fall. There is no supply out there because Funding for Lending has impacted the market." Spreads have been driven in since the summer, as investors chase what little paper is out there.
FFL works in a similar way to the European Central Bank’s three-year LTRO: in providing very cheap funding, it undermines capital markets issuance from eligible candidates. It provides liquidity where it is already there. The scheme is fuelling mortgage funding – for which the prime RMBS market was doing a fairly good job – but is unlikely to have any impact where it really matters: corporate lending. Indeed, the BoE’s credit-conditions survey for the third quarter of 2012 reported that while the availability of secured credit to households had "increased significantly in the last three months", the availability of credit to the corporate sector was unchanged and was likely to remain so during the fourth quarter. Indeed, loans to private, non-financial companies fell £1.2 billion in August
Stimulating SMEs’ funding by the banks is proving a difficult nut to crack. SMEs are highly exposed to financial deleveraging because these loans are the least attractive to banks. They come with greater risks; if they are non-investment grade, the capital charge is high; and unlike forging relationships with larger companies, there is less opportunity to generate additional fees through capital markets transactions, hedging or other business.
The UK government’s Business Finance Partnership (BFP) is specifically designed to boost non-bank lending channels. Five funds are due to be launched shortly, with the government co-investing up to £1 billion. Although the mandate winners are reluctant to discuss their participation ahead of the announcement by the Treasury, some well-known names will be involved.
These initiatives are broadly welcomed. "Policy has evolved from managing the price of money through interest rates and quantitative easing, to trying to manage the supply of money through the credit channel," says Standard Life’s head of global strategy, Andrew Milligan. "Given that the economy is flat-lining, that has to be worth a try, and fits with the unconventional response being demanded by [retiring Monetary Policy Committee member Adam] Posen and others."
Asset managers active in the loan business can point to a government seal of approval. ICG, which did not bid to take part in the first round of the BFP, is likely to participate next time.
"We initially thought the businesses it was aimed at were too small," says Jeff Boswell, head of portfolio management at the firm. "However, the enterprise value has edged up to a level that is more attractive for us, and it is good that the government sees the value and importance of non-bank credit."