The impact of COVID-19 on world economies might be the hot topic of the day, but most conversation on that front is still speculative. Economies evolve over the course of decades—and the dust from the 2008 financial crisis is still settling over 13 years later.
A prime example is the rise of non-bank lenders, which have stepped in to fill a void left by banks in providing credit to select retail segments: high-risk mortgages, consumer finance, car loans, and even SME loans. In the United States, 68% of all mortgages in 2020 came from non-banks—an increase of a whopping 10% year over year. Over half the U.S. mortgage market has been comprised of non-bank lenders since 2016.
Regulation and capital requirements like Basel 4, imposed as a direct result of the financial crisis, have caused traditional commercial banks to rein in their appetite for doling out credit. Many independent lenders gained accreditation as part of the Coronavirus Business Interruption Loan Scheme (CBILS) or similar schemes worldwide, and have played a substantial role in supporting SMEs throughout the pandemic.
According to the Finance & Leasing Association (FLA), approximately 36% of the £15.9bn loaned to SMEs in the UK in 2020 came from non-bank providers. And as traditional bank loans dry up in the U.S., non-bank lenders have stepped in to fill the void. What this means to consumers is a great deal more choice in the market—and in some cases, the possibility of funds that may not otherwise have been available.
Put differently, independent non-bank lenders are playing an increasingly important role in the global economy by providing funding where banks are less keen.
In this post, we’ll explore the kinds of loans non-banks are taking on, how they’re funded, and what the future looks like for modern lending methods.
Non-bank lenders are taking on higher-risk loans
Lending areas viewed as higher risk include:
- Higher loan-to-value (LTV) mortgages
- Buy-to-let mortgages
- Mortgages for individuals with challenging credit history
- Vehicle financing
- Credit cards
- Consumer finance
- SME lending
Where changing risk appetites created the catalyst for the shift toward non-bank lending, today’s market structure is increasingly collaborative. Many independent lenders actually work with banking institutions via wholesale funding facilities, as banks recognise that smaller lenders can secure a wider distribution of funding. They are also better able to support customers through forbearance requests and other payment fluctuations since smaller institutions tend to be more flexible than banks.
That said, risk remains a potent factor. Non-bank lenders typically focus on the higher-margin and higher-risk loans, where high interest rates (and therefore high return) are most common. Low LTV prime mortgages, with their lower risk and lower return, are still largely the realm of traditional bank lending.
While high-margin lending may sound opportunistic, non-bank lenders perform a service that is desperately needed by many as banks opt to loan less. They have effectively extended credit options to areas of the economy that would otherwise go without.
How are non-bank lenders funded?
Thanks to low interest rates, private equity firms have been able to set up non-bank lenders in a highly leveraged manner. These non-bank lenders don’t typically rely on deposits to fund their services, but instead seek funding in the wholesale capital markets, where efficient financing opportunities exist from global institutional investors. This means secured funding in warehouses initially, followed by securitisation vehicles.
The granular retail-focused nature of most non-bank loans (mortgages, consumer loans, or car loans, for example) is ideal for securitisation markets. Securitisation transactions can present a wide range of challenges for issuers and their advisors. From conception to pricing and closing, firms must consider relevant regulatory, accounting, tax and compliance requirements.
The future of non-bank lending
In the years leading to the 2008 financial crisis, non-bank lenders contributed to the housing bubble by issuing loans to high-risk borrowers. Instead of funding the loans with secured deposits, many lenders borrowed against lines of credit before selling those mortgages to investors. When the crisis hit, many lenders simply collapsed.
Some fear that the rise of non-bank lending is a signal that markets in the U.S. and elsewhere have returned to the same high-risk practices that created the 2008 crisis and recession. While caution around lending practices is certainly warranted, it’s an undeniable fact that non-bank lenders are providing a desperately needed source of funds to many in these uncertain times.
With the proper programmes in place, non-bank loans can remain a critical source of funding for individuals and SMEs for years to come.
IQ-EQ has over 20 years of experience in securitisation services
IQ-EQ’s flexible, agile team is located across Europe, the U.S., and Asia. With localised expertise in key jurisdictions, we are well-equipped to handle anything from private or warehouse transactions to multi-tranche, multi-currency benchmarks. We have the experience, technology, and expertise to support any transaction throughout its life cycle, ensuring that everything runs smoothly and cost-effectively. And with our emphasis on client support and services, you’ll have all the expertise you need right at your fingertips.