Initiatives on non-bank finance

We are all generally aware of some of the issues around the current state of the western banking markets and its ability to lend. Some of the issues include:

• General availability of funds for investment grade corporates at reasonable margins, although the banks are currently fairly liquid and seeking to make their money work, thus helping this.
• Poor availability for borrowers of lower credit quality and when lent, at significantly higher margins than for investment grade, at least in comparison to recent history.
• Some very high grade corporates are avoiding the bank market for funds and only using bond markets.
• The huge uncertainty surrounding the implications of Basel III and Dodd-Frank for the major players in the western banking market and what it might mean for bank costs.

Many sectors depend on borrowed funds, especially from the banking market, and some of these include:

• Government (sovereign)
• Local government
• Property and housing associations
• Transport sector
• Infrastructure
• Private Equity

There are various initiatives in place to reduce dependency on the banking market in some of these sectors and for corporations generally. Commentators point to the US market where bond finance forms the majority of corporate debt, say about 2/3rd, whereas it is about 1/3rd in Europe. In the UK there are moves to make bonds more accessible to the public, with the London Stock Exchange promoting their market and several retailers (e.g. John Lewis) launching specifically retail bonds. At least two other sectors have also started a push towards bonds.

Local government is not a natural bond issuer but a shortage of government finance will push them towards bond markets.

Infrastructure has been funded by the bank sector and the bond market using Monoline wraps (guarantees), both of which have significantly reduced capacity. The European Union has launched an initiative to get the sector more financed by bonds, using the EIB (European Investment Bank) to give some credit support to the project finance structures.
It seems that we are coming to depend quite heavily on bonds, but bonds trade on long term interest rates and spreads, as well as other technical factors. Spreads are currently quite low and of course interest rates are also generally quite low. It is hard not to think that investors in bonds, especially the long term bonds needed in some sectors, might suffer as interest rates rise and spreads widen.

Although these projects need to be funded in some way, there is no law that says there will always be enough capital to fund them, especially when many western economies are facing problems with growth and their own sovereign credit issues. It seems that capital will be in short supply in the years to come.

http://ec.europa.eu/economy_finance/events/2011/2011-04-11-conference_on...
http://www.johnlewispartnership.co.uk/display.aspx?MasterId=fd5fb245-4f3...

By Will Spinney