Jamie Davidson, founder of debt advisory firm Conduit Finance and formerly of SME lending at Bank of Scotland and Clydesdale Bank, predicts a sea change for SMEs and commercial and residential property borrowers in Scotland, as alternative lenders look to offer reduced interest rates on their loans.
In 2018, Mr Davidson believes that for the first time, loans from alternative lending schemes such as crowd funding, peer to peer lending and private debt, will be as cost competitive as the retail banks, blowing the finance market wide open for loans in the £500k to £10m range. This will be especially beneficial for commercial and unregulated residential property borrowers that have been turned down for credit by the retail banks.
Mr Davidson said: “Naturally, because alternative lenders such as Funding Circle, The Route and Folk to Folk are settling loans for higher Loan to Value (LTV) ranges (between 60-75%), they absorb the risk by charging higher interest on both short and medium term loans – currently between 6% to 12% pa. LTVs in retail banking property loans are settled at around 55% to 60%, but they offer lower loan costs of between 2.5% to 5%. This is all set to change in 2018 – with increased availability of finance for lenders, such as Innovative Finance ISAs (IFIsa), the cost of capital is set to fall and this will encourage alternative lenders to reduce their interest rates.
In the future, it will be margins of risk that differentiate lenders, rather than the cost of borrowing. We won’t see lending flowed freely regardless of risk, as we did in 2005 and 2006, but it will be difficult to separate who is offering what and if an offering is competitive. We’re also likely to see alternative lenders offering terms to individuals and businesses with higher LTVs, as they continue to look to differentiate themselves from the retail banks and their alternative finance competitors. Once non-retail bank LTV's hit 80% in 2018, then we are heading for a correction which will happen around 2021.
The result is a more competitive and balanced financing market, as individuals and businesses have access to more cost competitive options outside of the banks. This is only going to be good for the wider economy, particularly smaller or new businesses that struggle for credit."
According to Mr Davidson, the trend of price competitive alternative finance will apply to many types of lending, including invoice discounting, asset finance, unsecured SME loans, property development finance and commercial mortgages. The move from alternative lenders is likely to be a major benefit for individuals and businesses that do not qualify for retail bank funding due to higher risk profiles.
However, Mr Davidson warns that banking regulation could check the reduction in loan costs offered by alternative lenders. He continues: “Offsetting the trend towards falling interest rates from alternative lenders, will be the increasing pressure that all regulated lenders have to comply with their ongoing obligations to the Prudential Regulation Authority (PRA) regarding capital adequacy - how much cash they need to set aside to cover any bad loans. In some quarters of the lender market, this will reduce the loan amount offered and increase interest rates. Retail banks are currently increasing pricing to ensure they meet their PRA obligations, this edged them up the pricing scale and closer to the alternative lenders."
Despite recent uncertainties, including Brexit and the triggering of Article 50, alternative lending has seen a sustained period of growth in recent years. For example, Peer-to-peer lending by volume reached over £100 million by the start of 2017 according to altfi (ref 1.). Bridging finance is also enjoying a period of positive growth in 2017. According to the Association of Short Term Lenders’ (ASTL), bridging lender members reveal that the value of applications for bridging loans increased by 13.9% in Q1 this year, compared to the previous quarter; up 123% over the same quarter in 2016 (ref.2). This is good news considering slow growth in bridging finance in 2015, up just 1.2% in that year (ref.3).
Lending in the UK commercial property sector is also buoyant. According to the 2016 Year-End De Montfort Commercial Property Lending Report, while new lending was down by 17 per cent in 2016, compared to its post-crisis peak in 2015, the vote to leave the EU seems to have had minimal impact on new lending activity. Lenders originated £21.4bn in the first half of 2016 and a marginally higher £23.1bn in the second (ref 4.).
William Fleischmann- Allen, Head of alternative finance lender, The-Route Finance said:
“2017 is a bit of a watershed year for alternative finance market – the launch of the Innovative Finance Isa for example, allows investors to deploy their tax free allowance with a more diverse risk appetite. This means that SME borrowers in need of funding will have greater access to investors who are willing to accept a higher risk. We’re also going to see a period of consolidation and cooperation, as smaller alternative lenders merge to offer optimum funding solutions for borrowers. This will ensure that lending opportunities are directed to the most appropriate funder, while both meeting the needs of UK businesses and filling the funding gap that the big banks have ignored for too long."
Competition drives innovation, so as lenders fight it out, borrowers can expect to benefit from not only lower rates and higher LTVs, but creative new to market products.