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After the maelstrom

The crisis and the lasting impacts for non-bank lenders Marc Bajer ChiefExecutiveOfficer Hadrian's Wall Capital “ It is at this very moment, however, when the NBLs are W hen the torrent came upon us, I had already just weathered, what now seems by comparison, a dripping tap. I have always fancied myself rather hardened by my experiences over the last 42 years. But it has taken in it, quite frankly up-to-theirnecks, that they must all decide what they are going to do next quite a number of crises before I realised just how resilient I was. with their still evolving, yet very Indeed, how resilient we all are. My father used to tell me, ‘Don’t panic just yet kiddo. I’ll tell you when.’ Well, he never did. well built, machines

In this article I will share some observations and provide some remarks on the challenges facing non-bank lenders (NBLs). I will also suggest possible approaches which may prove helpful in our joint effort to persevere and then thrive in the post COVID-19 world.

A sustainable model?

We’ve been lending to NBLs for quite a while now and we’ve always thought of our clients, and others we consider financeable, as an elemental feature of the vibrant and robust SME lending industry in the UK. But that conclusion has always relied upon the presence of three pillars: a sustainable and survivable financing structure, a disciplined credit-underwriting and operational lending infrastructure and, most importantly, some true believers running the joint. The second and third of these are aspects which we, as decision makers, can more or less, directly influence. The first is more of a conundrum. Pay less and live for today or pay more and live to fight another day. I know that my long-suffering clients have had to put up with my endless harping on this particular point – so you guys can look away now.

It is at this very moment, however, when the NBLs are in it, quite frankly up-to-their-necks, that they must all decide what they are going to do next with their still evolving, yet very well built, machines. I know that we are all doing what needs doing every single day; and it is a real slog. However, I think we may also, all of us, agree that the real challenges still lie ahead of us, after the storm has passed.

There are a number of the current conditions at play, and there is much to divine from them. NBL equity, already scarce, is becoming more so, as value has been eroded due to this period of acute systemic distress. Simultaneously, wholesale senior debt funding has also become constricted. Add to this that many NBLs have struggled to obtain broad recognition and reinforcement from the government (although slow progress is being made) for their key role in restarting the UK economy.

How to respond to these arduous structural conditions will be no easy task. New sources of senior debt funding with survivability features will be required and these will cost more. More equity,

or hybrid equity, will need to be procured and these equity sources must have their interests aligned with those of the senior management teams. The possibility of combinations and acquisitions will now need to be attentively considered. These strategies may need to be reinforced with modifications to lending and servicing criteria, operational and staffing requirements, and newly enhanced business interruption planning. Current conditions should be viewed as an opportunity to improve market positioning, operational capabilities, and financing structure.

Compounding factors

But that’s not the whole picture. We also have the status of the mainstream lending banks who, although having the appearance of increasing lending to SMEs, may simply be benefitting from (as I would) risk-diminished or risk-free government programmes. Moreover, the banks, although subject to substantial credit distress in existing loan books, are also able to partially offset this distress via a substantially reduced cost of funds and indirectly, lower capital charges, via government sponsored lending schemes. Further, they will now be rightly contemplating the adjustment of their risk criteria and lending appetites for SMEs and NBLs to account for the short to intermediate-term consequences of credit performance arising from the current troubles. Therefore, we could reasonably suppose that the terms and conditions on offer from banks for wholesale NBL funding, including duration, callability, rate variability and covenants may become more stringent, as a rule, in a post-COVID world.

As an NBL, I would not necessarily expect, nor would I plan for a return to pre-pandemic banking arrangements as the effect of the crisis is likely to have been hardwired into new internal banking procedures meant to deal either with imminent or possibly, future associated risks. All of this is likely to introduce, directly or indirectly, an uncertain and conceivably more competitive climate for NBLs where the SME risk/reward dynamic may shift, resulting in alterations to both the available configuration of credit opportunities and the power to price such credits. In addition, institutional investors, who have been stepping into the lending market for quite a while, had already been winged by the evolution of market conditions over the last 18-months before our current predicament. These have now been piled upon by the current crisis. Add to this the inevitable missteps which will naturally occur in the early stages of a direct lending, or any new investment strategy and you have a problematic institutional investor decision-making framework. Now in my experience such wounds are by no means fatal, but they hurt. Nevertheless, they might produce an interruption in strategic institutional investing behaviour at the very moment when a reset, such as this, should prompt the contemplation of longer-term SME and other direct lending strategies. “

Institutional investors, who have been stepping into the lending market for quite a while, had already been winged by the evolution of market conditions over the last 18-months before our current predicament

Institutional investor confidence

There can be little doubt that without the full involvement of the institutional investor community, it will be difficult for NBLs to produce the timely and durable deployment of the financial resources which will be required in order to move the economic needle and return to calmer conditions. As a consequence it will be necessary for the NBL and corporate finance intermediary community to build a clear, transparent and ongoing flow of SME credit performance, market penetration and industry evolution data in order to win and then retain the confidence of institutional investors in, what is for them, a still relatively new investment proposition.

Then we must consider lending metrics across industry groups, sectors, and geographies. We may all safely assume that initial recovery and performance improvement from today’s level of macro distress will occur at irregular rates and magnitudes among these classifications. This dynamic will produce a formidable challenge for NBLs who, while seeking to provide funding for those sorely in need, must also contemplate the effect of credit decision-making on their own performance, or even survivability. The resulting client triage will come at a heavy cost to certain borrower categories, but there is no avoiding it.

I should also mention again the position of current government support models, but in this case, their direct relevance to the NBL industry. I believe these programmes have likely achieved, what was always going to be, their limited objective. But we must continue the effort to convey to the government the growing importance of the NBL industry in the SME financing value chain so that, going forward, NBL’s form a core component, not only of national policy, but of specific industry remedies. We must not, however, place undue or strategic business reliance on such government measures but only insure our seamless access to them in time of need.

Market durability

Further, and as I have written previously, we live in a country that

has, unlike many others, a highly developed, specialised and widely dispersed NBL and corporate finance intermediary infrastructure. This is a singular advantage when trying to rebound from our current difficulties and I have already observed that the pipeline of NBL inquiry still appears to be outstripping the supply of funding available to them. And all this while NBLs, as a group, appear to be demonstrating acceptable relative performance and, I have remarked, a cool intrepidity under fire.

Finally, it is of the utmost importance that NBLs assess their strategic objectives fully with due consideration given to the importance of commercial durability, balance sheet stability and the measured pursuit of long-term success. Arising from such assessments, NBL decision-making regarding partnership choices, balance sheet structuring options, product criteria and pricing, corporate finance activities and strategic market positioning, must carefully note that existential threats are never expected but always seem to materialise, are not easily measured but always carry enormous cost and, as always, arise in limitless variety. “ We live in a country that has, unlike many others, a highly developed, specialised and widely dispersed NBL and corporate finance intermediary infrastructure