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Commercial Borrowing - UK - November 2015
Introduction
 
This report will explore the following key issues regarding commercial borrowing in the UK:

●	What are the key determinants driving commercial borrowing?
●	Was the market affected by the financial crisis? Have there been any structural changes as a consequence?
●	Has regulation restricted industry development?
●	Can alternative lenders make a significant impact? Or are mainstream lenders on the verge of a recovery?
●	What does the future hold for commercial borrowing?

Definitions
Commercial borrowing is a term used to describe a funding arrangement that a business can set up with a financial institution, which enables them to fund capital expenditures or other operations they would otherwise be unable to afford.

Commercial lending includes commercial property (real estate) mortgages, loans used to purchase buildings, equipment lending, loans secured by accounts receivable, and loans intended for expansion and other corporate purposes.

The following three sectors best highlight the development of the commercial borrowing industry and are also quantified in this report:

●	Commercial property (real estate) finance
●	SME finance
●	Alternative finance

Lending is defined by the Bank of England as “loans and advances (including overdrafts and claims made under sale and repurchase agreements) and finance leases granted to nonfinancial businesses, in all currencies”. 

Data on gross flows of lending, meaning flows of new lending to and repayments of lending by businesses, are defined with respect to loans excluding overdrafts. Overdrafts are excluded from the definition of gross lending flows because the concept is difficult to define sensibly for credit products with shortterm revolving characteristics. 

Gross flows of lending and repayments and thus net lending, are defined to exclude the effects of write-offs, revaluation effects, and loan transfers. 

For non-financial businesses, amounts outstanding of loans (excluding overdrafts) and overdrafts are measured exclusive of accruing interest payable. 

Gross lending and repayment flows are measured after the application of any interest charges to the loan accounts. This means, for example, that gross lending data include the application of any ‘capitalised interest’ and repayments data is measured after the deduction of any interest charged to the account.

Other terms used in this report include:

Accounts receivable – money owed by customers to another entity, which has not yet been paid for. Receivables tend to come in the form of operating lines of credit and are usually due within a short time period.

Asset-based finance – a method of providing structured working capital and term loans that are secured by accounts receivable, inventory, machinery, equipment and/or property.

Bad debt – a debt that is not collectible and is effectively worthless to the creditor. This tends to occur after all attempts have been made to collect on the debt and is usually a product of the debtor going into bankruptcy or where the additional cost of pursuing the debt outweighs the amount the creditor would collect.

Commercial credit – a pre-approved amount of money issued by a bank, or other lender, to a company that can be accessed by the borrowing company at any time to help meet various financial obligations.

Crowdfunding – a way of raising finance by asking a large number of people or business owners for a small amount of money. Debt crowdfunding involves investors receiving their money back with interest (also known as peer-to-peer lending). Equity crowdfunding involves investing in an opportunity in exchange for shares or a small stake in the business, project or venture.

Effective interest rate – the weighted average of all interest rates across each type of deposit or loan account held by all the clients within an economic sector.

Hire purchase – a system in which a company pays for an item or service in regular instalments, while having the use of the specified item or service.

Insolvency – when a business can no longer meet its financial obligations with its lender or lenders, as debts become due.

Invoice trading – the process in which companies, particularly SMEs, auction their invoices online as a way to gain quick access to money that would otherwise be tied up.

Liquidation – when a business or firm is terminated or made bankrupt, its assets are sold and the proceeds pay creditors.

Loan write-offs – after a period of time, as dictated by regulations, has passed for banks or other lending institutions to collect ‘bad debt’, the institution must ‘write-off’ the loan and expect the debt to remain unpaid.

M4 lending – sterling lending by MFIs to the M4 private sector, including advances, acceptances, reverse repos, investments, and holdings of short-term paper.

Monetary financial institutions (MFIs) loans to non-financial businesses (NFBs) – lending in all currencies to all UK non-financial businesses classified to non-financial industry sectors.

(Net) Rate of return – the gain or loss on a loan over a specified period, expressed as a percentage increase over the initial loan amount.

Non-financial corporations – corporations that produce goods and services for the market and do not, as a primary activity, deal in financial assets and liabilities.

Peer-to-peer business lending – a method of debt financing that enables companies to borrow and lend money without the use of an official financial institution as an intermediary.

Syndicated loan – a loan offered by a syndicate of lenders, who work together to provide finance for a borrower. The loan may involve fixed amounts, a credit line, or a combination of the two. Interest rates can be fixed for the term of the loan or floating – based on a benchmark rate, such as the London Interbank Offered Rate (LIBOR).

All values quoted in this report are at current values unless otherwise specified.

Some numbers in tables do not add up due to rounding methods.

Methodology
Reports are researched and written by MBD’s in-house, specialist business-to-business consultants. Research is based on both an analysis of official information and on original, trade research, providing both a quantitative and qualitative view of the market. MBD’s unique range of frequently updated reports provide an integrated body of ongoing research, enabling deep understanding of the prevailing trends and the drivers of these trends based on trade opinion.

Abbreviations 
The following abbreviations appear in this report:

BBA | British Bankers’ Association
BBB | British Business Bank
BIS | Department for Business, Innovation & Skills
BoE | Bank of England
CPI | Consumer Price Index
EFG | Enterprise Finance Guarantee
EU | European Union
FCA | Financial Conduct Authority
FLS | Funding for Lending Scheme
FTSE | Financial Times Stock Exchange
GDP | Gross Domestic Product
GVA | Gross Value Added
HMRC | Her Majesty’s Revenue & Customs
ICAEW | Institute of Chartered Accountants in England and Wales
ISA | Individual Savings Account
IT | Information Technology
LBG | Lloyds Banking Group
M&A | Mergers and Acquisitions
MBD | Market and Business Development
MFI | Monetary Financial Institutions
MPC | Monetary Policy Committee
NBCP | Non-Bank Credit Provider
NFB | Non-Financial Businesses
NLGS | National Loan Guarantee Scheme
OBR | Office for Budget Responsibility
ONS | Office for National Statistics
P2P | Peer-to-Peer
P2PL | Peer-to-Peer Lending
PNB | Permanent Non-Borrower
PNFC | Private Non-Financial Corporations
PRA | Prudential Regulation Authority
PTP | Pre-Tax Profit
RBS | Royal Bank of Scotland
RPI | Retail Price Index
SME | Small and Medium-sized Enterprise
UAE | United Arab Emirates
UK | United Kingdom
UKFI | United Kingdom Financial Investments
US | United States of America
VAT | Value Added Tax

Market positioning 
Commercial lending by all banks and building societies to financial and non-financial businesses started to diverge during the general acceleration in lending in the years preceding the financial crisis. Lending to financial businesses (partly to fund asset-based finance) rose faster than direct lending to the ‘real economy’, although that gap has narrowed in recent years.

Over the last few years, the shape of the borrowing landscape has changed significantly, particularly after the onset of the recession in 2008/09. More recently, many companies have taken the opportunity to strengthen their balance sheets by refinancing amid low interest rates and greater liquidity in the capital and equity markets.

Commercial credit is provided primarily by banks, with large companies typically having easier access to bank lending than smaller businesses. There are also a number of alternative lending solutions available, including capital markets, such as bond and equity markets; assetbased finance; leasing and hire purchase; and the growing alternative of peertopeer or crowdfunded lending.

The lending industry continues to grow and be refined, with greater diversity of business funding available today than during any other period. Business owners can choose from short and long-term secured and unsecured loans, merchant cash advances, start-up loans, accounts receivable factoring, business acquisition loans, lines of credit, equipment financing, professional loans, equipment refinance loans, equity loans (such as interestonly, shortterm loans), working capital loans, and peertopeer loans.

Because of the diversity of lenders and loan terms on offer, it is becoming difficult for borrowers to identify the best sources of finance. Consequently, borrowers are increasingly turning to finance advisors, who can supply an appropriate lineup of lenders and competitive finance quotes. This is important given varying borrower objectives and business plans.

Before the latest financial crisis and during the past three decades, bank lending and GDP broadly followed each other – excluding between 1992 and 1994, when post-recession lags in lending fell approximately 18 months behind the GDP trend.

The financial crisis was followed by a collapse in bank lending as banks undertook the painful task of rebuilding their balance sheets, drastically cutting new lending, and increasing lossabsorbing capital.

More recently, however, conditions have improved for larger companies and, over the past year, SMEs. The gradual loosening in conditions for traditional banksourced corporate credit has been accompanied by structural shifts in the nature of the market, including the increased use of capital markets, and, more recently, other types of investors, as firms have sought alternative sources of finance. Loan book repair, competition, and the emergence of challenger banks have also contributed to a recovery in the market.

For large firms, bond and equity finance has increased in importance relative to bank loans. For SMEs, collaborative and peertopeer funding platforms have started to reduce their traditional reliance on bank lending. The emergence of alternative lenders in the UK has also given banks greater opportunity to ‘pick and choose’ who they lend to, as they know that alternative lenders are more likely to finance riskier ventures. Alternative lenders have invested vast amounts of money, gaining market share from traditional, mainstream lenders.

Despite this, bank loans still dominate the market. According to the British Banker’s Association, total loans from UK banks to SMEs stood at £89.7 billion at the end of 2014, while P2P lending was less than 20% of the flow of net bank lending to SMEs in the first half of 2015. Alternative sources of funding therefore still only represent a small portion of the overall market, but alternative finance is growing and likely to be a developing feature of the market in the future.

The most recent BoE data suggests that the early post-crisis trend in lending has been gradually reversed. The data shows a gradual improvement in net lending since 2012, with net lending on all currency loans of £3.1 billion in Q2 2015. The annual growth rate in the stock of loans in May 2015 was 0.9%, having been negative for much of the period since the financial crisis.

Key analysis: However, there has been a shift in lending practices due to the implementation of new regulations. A survey conducted by Deloitte in 2015 found that 40% of bank professionals believed they had changed their lending strategy over the last year. A large number of banks exited non-core asset classes, with more than half increasing their focus on lending to SMEs. With stronger competition in the borrowing market, many banks reported lower fees and margins with fewer conditions and increased leverage multiples for borrowers.

The commercial borrowing market was more active in 2014 than in any previous year since the financial crisis. This occurred due to the continuation of the recovery that started in previous years, helped by the stability and slow growth of the UK economy, and interest rates remaining at historically low levels.

Larger companies have access to more bank lending sources than smaller businesses, such as the syndicated lending market. The total value of new gross syndicated lending facilities granted in the UK in Q2 2015 was £17.3 billion, lower than the value granted in the same period last year. 

In recent discussions, some major UK lenders reported that a decline in activity in this market partly reflected companies bringing forward refinancing activity from 2015 to 2014. By contrast, activity related to mergers and acquisitions reportedly began to increase. Many larger businesses are able to access equity and debt capital markets directly, which has somewhat reduced total bank borrowing. However, access to these markets tends to be restricted to larger businesses, meaning that smaller businesses must seek alternative funding streams.

The overall availability of credit to businesses remained unchanged in 2015 Q2, according to respondents to the BoE’s Credit Conditions Survey. Looking further back, the survey suggests that credit availability has improved since late 2012. Credit appeared more widely available for large companies than small firms, with large corporates more readily able to access funding from both bank and non-bank sources. Overall, demand for lending appeared to have increased over the last quarter. Lenders in the survey reported that demand had increased for small businesses and large corporates in Q2, but remained unchanged for medium-sized businesses. Lenders cited commercial real estate and mergers and acquisitions activity as factors pushing up credit demand.

According to the Bank of England, there are 311 banks operating in the UK. The British Banking Association suggests that, following consolidation, whereby overseas banks retreated to their domestic markets during 2004 and 2005, the number of banks has remained fairly constant until 2011. However, a 9% fall occurred in 2012 and 2013 following amid consolidation. Thirty years ago, 590 banks were in the UK’s banking sector. 

The industry is regulated by the Financial Conduct Authority and the Prudential Regulation Authority, which replaced the Financial Services Authority in April 2013. Both the FCA and PRA approve new entrants to the market, while the PRA has responsibility for prudential issues and the FCA for conduct issues.

HSBC, Lloyds, the Royal Bank of Scotland Group, and Barclays are the main recognised players in the UK commercial borrowing sector, while global institutions, such as Santander, also have a presence in the UK.

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