Non Bank Lending to Corporates

There has recently been much comment on non bank lending in the UK and this blog is designed to educate those who may not be familiar with the concept. The commentary started with an HM Treasury (UK government) discussion paper on the subject which has led to comment (including by the ACT) and the UK budget has also mentioned various issues surrounding this. While the commentary started in the UK, the issue is global and applies to any country.

The very largest firms have always been able to access non bank finance in the form of bonds, issued to either the public or professional investors, usually in the largest markets such as the UK, US and Europe. For the largest firm this has given more debt capacity (and possibly cheaper) than might be available in the bank market, much longer term finance than might be available in the bank market and a very valuable source of diversification from banks, thus reducing refinancing risk as part of a financial strategy. Some of the key features of these bond, non bank markets are:

• The funds are fully drawn, they cannot be repaid and re-drawn, like a revolving credit facility or overdraft
• The interest rate is usually fixed
• It is very difficult to repay the debt early and if it can be repaid, there is often a premium, especially for lower grade borrowers paying a significant margin (spread)
• There are few covenants (except for lower grade borrowers)
• It is very difficult to negotiate with bondholders for amendments (in contrast to a bank)
• There is no need to consider offering ancillary facilities often requested by banks

This non bank market has expanded in several ways over the years

• Bonds are also issued by lower grade borrowers (High Yield Bonds), very often in support of Private Equity structures or deliberately geared situations such as large takeovers
• Private Equity houses have often made loans for strategic reasons and hedge funds have been occasionally known also to participate as lenders
• Private Placement markets, particularly in the US, are very liquid
• In some countries, cash rich institutions participated in leasing transactions
• Some bank deals have incorporated non bank investors in so called Term B and Term C type structures

(Note that commercial paper is also a non bank market but excluded here as it is short term)

Much of the present reaction is in reaction to the significant stress on bank balance sheets, seeking disintermediation. However banks carry out a fundamental role in an economy in making credit investigations and allocating capital. It is quite demanding for non banks to take on this role. The present push in the UK is to focus on a Private Placement market in the UK / Europe.

The key things to remember when considering non bank finance are broadly:

• It is difficult to negotiate with the lender for amendments etc
• The finance is almost always fully drawn
• There are big implications for disclosure of private information outside the banking sector
• There is no ancillary business (meaning possibly higher prices but less pressure)
• The loan may well be tradeable so that there is no visibility into lenders
• Pricing of loans may be publicly available to support the traded market
• There may be issues of withholding tax causing grossed up interest payments to be required
• There is more likely to be a repayment penalty than with bank lending
• They do reduce refinancing risk and do increase amount of funds available

HM Treasury discussion paper on non-bank lending - ACT response | ACT
www.hm-treasury.gov.uk/d/non_bank_lending_discussionpaper.pdf
Norton Rose Group - Essential corporate news - week ending 29 January 2010

By Will Spinney