At the end of this month, the Bank of England’s cheap-money scheme, Funding for Lending, will no longer apply to residential mortgage lending and will focus only on providing credit to businesses – small and medium-sized enterprises (SMEs) in particular, including property companies.
According to Capital Economics, this refocusing “can only be positive for commercial property”. SMEs make up 88% of UK firms and giving these occupiers access to easier and cheaper debt may boost space take-up and put upward pressure on rents.
Kelvin Davidson, property economist at Capital Economics, adds: “FLS is not directly targeted at commercial property investment or development, but will have indirect effects; it may help unlock pent-up [occupier] demand.”
Launched in July 2012, FLS was meant as a temporary measure to ease the credit crunch by giving UK banks and building societies low-cost funds so they could lend more to households and businesses. The quantity of money is linked to their lending performance and last April the scheme’s drawdown was extended to January 2015.
But worried by house price rises, the Bank is limiting FLS to business lending and has also skewed the scheme towards small firms by allowing banks to draw £5 in the scheme for every £1 of net lending to SMEs. The fees have also been set at 25 basis points, the lowest point on the previous charging scale, for drawdowns during the extended period.
The 42 lenders signed up to FLS so far had £23.1bn of FLS funds outstanding at the end of September, just over half of that drawn by Lloyds and Barclays (see table). Banks’ lending to households – notably residential mortgages – has risen, but business lending, especially to SMEs, remains muted.
Of the main high-street banks, Barclays, Lloyds, RBS and Santander all participate in FLS; HSBC does not. Of the former four, only Lloyds and Santander lend FLS funds to commercial and residential property firms.
The two heaviest users both drew a net £6bn each from FLS by the end of Q3 2013 (see table). But while Barclays loaned out a net £6.6bn, or 3.5% extra on top of its 2012 loanbook, Lloyds’ 2012 loanbook shrank by £2.25bn. For RBS and Santander, the shrinkage is even more dramatic. Both had less recourse to FLS; RBS drew £750m, which is still outstanding; Santander initially took £1bn, but is almost out of the scheme, with only £100m outstanding.
Shrinking loanbooks are not necessarily bad news, as they are likely to reflect banks’ working out of bad property loans. Indeed, the deleveraging process has accelerated, with commercial property’s share of total UK banks’ loanbooks dipping to 8.9% in November, the lowest level in a decade.
This is encouraging, says Davidson, because it shows banks entering the final stage of deleveraging. “They can now get rid of stuff without undermining balance sheets and can start to lend again,” he says.
FLS helps Lloyds take big step forward in small business lending
“FLS has been important in growing our SME lending 5% year on year,” says Stephen Pegge, Lloyds’ director of SMEs and mid markets. “We entered 2014 with a record pipeline and expect it to be a strong year.” Lloyds is one of the larger FLS users, with £6bn of drawings outstanding as of Q3 2013. It uses the funds to cut interest rates by 1% on all new loans to businesses, commercial mortgages and hire purchase; this applies to SMEs, which Lloyds defines as businesses with up to £25m turnover, and mid-market companies.
Lloyds has a total £25bn of drawn lending out to SMEs. “Property is an important part of the book,” says Pegge. “Lloyds intends to continue including real estate businesses as eligible for the 1% discount on term loans to SMEs,” he adds. It also uses FLS for lending to mid-market companies, defined as those with turnovers between £25m and £750m. Loans can be up to 25 years, or longer for some agricultural ones, and mid-market loans include a break at five years.
“Investment property is still a strong part of our business and we’re seeing more demand for residential development, even from SMEs, which we’re keen to support,” says Pegge. There are also non-real estate SMEs with a property side-line, which “need more room, so develop a bigger building and sublet part of it. Businesses are looking to diversify their income stream. If they have money to invest and see an opportunity to buy property in their area or next door, they’re interested,” says Pegge. Buy-to-let, in the form of business people building up residential investment portfolios, also remains strong.